The post Kumar interviewed by Bloomberg HT on central bank digital currencies appeared first on Atlantic Council.

The post Kumar and CBDC tracker cited by the Observer Research Foundation appeared first on Atlantic Council.

In this edition of the Global Sanctions Dashboard, we walk you through existing sanctions against the Wagner Group, limitations around enforcing them, and what more Western allies can do to counter Wagner’s influence in Africa. Moreover, we identify gaps in beneficial ownership information as the key vulnerability in enforcing sanctions against Russia, including in the case of the oil price cap.

The Wagner Group is heavily sanctioned but keeps making money

The Wagner Group, its affiliates, and leadership are the targets of Australian, British, Canadian, European Union (EU), Japanese, and US sanctions for human rights abuses and serious crimes, among other illicit activity, and for participating in Russia’s war of aggression against Ukraine. There are proposals and discussions in play within the EU and UK governments to designate the group as a terrorist organization. The United States redesignated the Wagner Group as a transnational criminal organization in January 2023. While these types of organizational designations may appear symbolic, they pave the way for more significant sanctions and actions such as prosecution of group members and affiliates pursuant to terrorism or criminal charges, which carry significant penalties. Terrorist organization and transnational criminal organization designations also send a strong signal to foreign governments that they may want to reconsider their relationships with these groups.

Shortly after the Wagner Group’s attempted mutiny against Moscow’s military leadership, the United States issued designations targeting the Wagner Group’s illicit gold activity and affiliated entities in the Central African Republic (CAR), United Arab Emirates, and Russia, exposing Prigozhin’s network and mining operations. Concurrently, the United States issued a twenty-nine-page joint advisory on Wagner’s illicit gold trade in sub-Saharan Africa, encouraging industry participants to apply enhanced due diligence to avoid the risks potentially facilitating the violation of economic sanctions or money laundering. 

Despite sanctions and efforts to curtail the Wagner Group’s illicit activity, the group has successfully evaded financial sanctions through a series of facilitators and front companies around the world and by taking advantage of lack of beneficial ownership to obscure operations and avoid identification. The Wagner Group has made more than five billion dollars since 2017, according to a Forbes assessment, mainly from mining, illicit gold trade, and forestry business in Africa, as well as funding from the Russian state. 

The restructuring of Wagner Group’s command and control creates new opportunities in Africa

Despite the mutiny, Russia is likely to continue using the Wagner Group as an irregular or “gray zone” instrument of foreign policy and regional influence across Africa, although some rebranding and restructuring of the organization is expected. The Kremlin could change the Wagner Group’s name but will likely keep the existing security contracts with African authorities and continue using the group for disinformation operations. Reportedly, the Kremlin has already begun the “corporate takeover” of the Wagner Group, with Russian law enforcement authorities seizing computers from companies connected to Prigozhin. 

Nevertheless, the Wagner Group’s organizational restructuring in Russia will likely impact the group’s operations in Africa as the Kremlin moves to assert greater control over Wagner Group operations and personnel and demonstrate that Putin is still in power. For example, around six hundred Wagner Group mercenaries left the CAR following Prigozhin’s failed rebellion, however the reason for their departure remains unknown. Russian government officials have been traveling to Africa and the Middle East in recent weeks to reassure regimes that Wagner Group will be able to meet their existing contract requirements under new command and control. In a visit to Damascus on June 26, Russian Deputy Foreign Minister Sergei Vershinin assured Syrian President Bashar al-Assad that Wagner forces would continue operations under the control of the Kremlin. In the CAR and Mali, Russian Minister of Foreign Affairs Sergey Lavrov offered similar assurances. 

The Kremlin’s attempts to save face and assert control provide Western allies with an opportunity to counter the Wagner Group’s influence and position, particularly in African countries such as CAR and Mali. The United States and its allies can take a “demand-side economics” approach and introduce positive inducements for regimes currently contracting with the Wagner Group, such as diplomatic, economic, and security cooperation that meet the needs of African countries while swaying them away from their reliance on the Wagner Group and ultimately Russia. 

The United States could leverage its designation of the Wagner Group as a transnational criminal organization to share information with foreign partners about the Wagner Group’s criminal activity, human rights abuses, and illicit financial activity to encourage partners to open investigations within their jurisdictions and prosecute Wagner Group personnel as criminals. These prosecutions could be brought to international organizations such as Interpol, to issue Red Notices and engage law enforcement around the world to bring criminals to justice. Further, if the United Kingdom and EU designate the Wagner Group as a terrorist organization, it may deliver a reminder to African governments that terrorism remains a priority and that the West is willing to cooperate with African governments on internal national security threats. A terrorist designation would also allow the EU and United Kingdom to bring terrorism charges against Wagner Group personnel within their jurisdictions and create the ability to further sanction the group and its network, disrupting their financial activity and ability to travel.

Additionally, Western allies can seize the opportunity to raise awareness about Wagner’s lack of success in places like Mozambique and Libya, human rights abuses in African countries, and exploitation of natural resources, to emphasize that their services come at a high cost. Western countries can partner with civil society organizations and African governments to track and identify the complex ownership structures of the Wagner Group-connected companies that enable sanctions evasion, share intelligence on these companies among partners, and take steps to freeze and seize assets of the Wagner Group that run counter to the interests of African countries. 

Identifying a key vulnerability in Russia sanctions enforcement: Beneficial ownership 

The key to understanding who is behind the shell companies and complex ownership structures of companies facilitating the Wagner Group’s activity is identifying the real human beings or organizations that control shell companies. They are called “beneficial owners.” 

The Financial Action Task Force (FATF), the international body responsible for setting global anti-money laundering standards, has called on its members to implement tougher global beneficial ownership standards and give competent authorities adequate information on the true owners of companies. Several countries, including the United States and United Kingdom, have passed legislation and developed or are in the process of developing regulations to bring their countries’ anti-money laundering and countering-the-financing-of-terrorism regimes up to FATF standards on beneficial ownership. 

The FATF and the international Egmont Group of Financial Intelligence Units (FIUs) can collaborate to ensure FATF regional bodies representing African countries and FIUs across the continent have the information they need and the capacity to understand and identify the risks the Wagner Group’s activities present to their respective domestic financial systems as well as the global financial system. 

Lack of knowledge on beneficial ownership also played a key role in obstructing the enforcement of the oil price cap against Russia. The United States and Group of Seven (G7) allies imposed a sixty-dollar cap on Russian crude oil in December 2022, with the goal of keeping oil flowing out of Russia while reducing the revenue stream into Moscow. The effectiveness of the price cap strategy depends on Russian oil exporters and importers accessing maritime services, such as insurance of oil tankers, provided by G7 countries that have sanctioned Russia. If Russian oil importers and exporters want to use these maritime services, which make up 90 percent of the market, they have to comply with the price cap. In response, Moscow built up a shadow fleet of oil tankers whose real owners are unknown. 

Why Russia’s shadow fleet is so dangerous

In February 2023, Russia’s shadow fleet was worth more than two billion dollars and consisted of around six hundred vessels. The fleet includes tankers previously used for Iranian and Venezuelan oil shipments and European tankers sold to Middle Eastern and Asian owners since Russia’s invasion of Ukraine began. The tankers operate without Western insurance and are not up to Western safety standards for oil tankers. Most of them are owned by offshore companies based in countries such as Panama, the Marshall Islands, and Liberia.

A third of Russia’s shadow fleet tankers are more than fifteen years old, which poses heightened risks of oil spills and environmental disasters. Normally, tankers should be demolished when they are around fifteen years old. The average age of the shadow fleet is twelve years and many of them will surpass fifteen years in the coming years. 

Fortunately, Asian nations have strengthened monitoring and inspection of old tankers. For example, Singapore held a record thirty-three tankers for failing safety inspections. Even Chinese port authorities in Shandong province have held at least two tankers older than twenty years for safety checks. Ships under detention for safety violations will have to re-apply for certificates and it’s unclear how long it will take them to get back to the ocean, if at all. 

How to prevent the growth of the shadow fleet

Last year, the number of undisclosed buyers of tankers more than doubled compared to 2021. Buyers of most of these tankers were located outside of G7 countries or the European Union. Specifically, London-based company Gibson Shipbrokers estimates that around one hundred fuel tankers were sold to companies outside of the G7. The undisclosed buyers of European ships most likely were shell companies or individuals acting on behalf of Russian beneficial owners of the shadow fleet tankers. This development is alarming and demonstrates a common theme in the challenges associated with enforcing sanctions against Russia including the oil price cap—beneficial ownership. 

Following FATF’s recommendation to its member states on making the identities of true owners of companies available to competent authorities could make it more difficult for sanctions evaders and money launderers to facilitate transactions for sanctioned Russian companies. It could also help sellers of tankers to identify whether the ultimate benefactor is a Russian entity or an individual. In the meantime, greater information sharing between partner nations on illicit Russian financial activity and the shell companies that are involved will help close this gap in sanctions enforcement and increase global understanding of Russia’s reach.   

Kimberly Donovan is the director of the Economic Statecraft Initiative within the Atlantic Council’s GeoEconomics Center. Follow her at @KDonovan_AC.

Maia Nikoladze is the assistant director at the Economic Statecraft Initiative within the Atlantic Council’s GeoEconomics Center. Follow her at @Mai_Nikoladze.

Ryan Murphy is a young global professional at the Atlantic Council’s GeoEconomics Center.

Castellum.AI partners with the Economic Statecraft Initiative and provides sanctions data for the Global Sanctions Dashboard and Russia Sanctions Database.

Global Sanctions Dashboard

The Global Sanctions Dashboard provides a global overview of various sanctions regimes and lists. Each month you will find an update on the most recent listings and delistings and insights into the motivations behind them.

Explore Here

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Global Sanctions Dashboard: Sanctions alone won’t stop the Wagner Group  appeared first on Atlantic Council.

The post Kumar quoted in Axios on cryptocurrency regulation appeared first on Atlantic Council.

The post Lipsky quoted in Business Insider on de-dollarization appeared first on Atlantic Council.

The post “Fractured foundations: Assessing risks to Hong Kong’s business environment” report cited by Chatham House appeared first on Atlantic Council.

The post Norrlöf quoted in Business Insider on dollar dominance appeared first on Atlantic Council.

The rise of sustainable investing in the private sector

Mobilizing private sector capital to boost sustainable development and ESG priorities makes sense given the numbers. With the top 500 asset managers holding $131.7 trillion in Assets Under Management (AUM) and the combined market capitalization of the top ten global companies reaching over $10 trillion in 2022, the private sector is well-positioned to contribute. Moreover, sustainable investing, mostly in renewable energy, was the fastest growing Foreign Direct Investment (FDI) theme in 2021—with 70% directed to developing countries. Up until 2021, financial markets have also experienced large shifts toward sustainable investing, with ESG fund issuance increasing by 53% to $2.7 trillion in 2021, while the green, social, sustainable and sustainability-linked bond market rose $1 trillion, grabbing 10% of the global debt market share. Sustainable companies also issued $48 billion in new equity, while sustainable lending reached close to $717 billion in borrowing. For example, in Indonesia, companies like Pertamina Geothermal Energy are looking to issue green bonds to help grow its business but also facilitate the transition to clean energy.  

Meanwhile, multinational corporations (MNCs) are integrating sustainability metrics into their supply chains, based on the Science Based Targets Initiative (SBTI). Financial and reputational risks from poor ESG practices can negatively impact a company’s future profits and resilience, which filter down to its local value chain. Many MNCs, including, Nestle, PepsiCo, and Unilever, are working towards preventing this by establishing and adhering to SBTI targets to increase sustainable practices within their global supply chains. Others, including Starbucks, are diverting funds to support climate and water projects in developing countries in an effort to conserve or replenish 50% of the water they deplete through their operations, including the agricultural supply chain. 

Together, ESG investing and SBTI targets should contribute significantly to sustainable development and lower the cost of hitting the SDGs. However, last year revealed several barriers that threaten that potential.

Roadblocks to investing in sustainable development

Sustainable finance faced challenges in 2022 as increased global regulatory scrutiny and divergent ESG standards led to a dip in ESG investing. Reuters reported that in 2022, sustainable investments reversed course for the first time in a decade, with sustainable bond sales decreasing by 30% and green bonds down 23%. Overall, ESG performance declined by nearly 9%, as international investment in ESG, especially climate change, declined.

Varying ESG rating standards, methodology, and data sources, that are often reclassifying sustainably labelled products, contributed to lower levels of ESG investing in 2022. Several ESG labelled securities were downgraded due to criteria conflicting with both major ratings agencies, while conflicting or overly prescriptive requirements led to a decline in support for ESG related shareholder proposals and the withdrawal of several financial industry members from regional ESG alliances. With over 600 ESG data providers, globally, it is not surprising a lack of consistency and standardization leave investors confused about the true risks and rewards from sustainable finance. Recent research reported that 20 of the 50 largest global asset managers assess their sustainable finance products using four or more ESG rating providers, while the other 30 use internal models for the same purpose. Underlying biases in ratings can often exclude developing countries struggling to attract sustainable finance due to inherent country-specific risks, like fossil fuel dependence, budget constraints, and high sovereign debt from external shocks, market access, and lack of technological innovation. However, some asset managers, like Abrdn, have developed in-house ESG ratings system based on data and metrics from external sources, like the World Bank and IMF, to consider unique factors when evaluating alignment with the SDGs for companies listed in their Emerging Markets Sustainable Development Corporate Bond Fund. 

Global regulations for ESG have also complicated cross-border sustainable investing, potentially leading to an increase in compliance costs and reduction in the number of eligible sustainable funds for firms.  Although evolving European, UK, and US frameworks regulating ESG have similar objectives, the approaches towards sustainable investing vary among the jurisdictional regulations and oversight bodies, especially around labelling and reporting. This disparity has also encroached on the Asia-Pacific financial industry, where many banks are starting to require local asset managers to comply with European ESG standards despite the existence of similar local regulations.  An analysis of ESG and sustainable-labelled funds identified that less than 4% meet the standards of all three jurisdictions, while 85% do not comply with any of them.  Additionally, different jurisdictional requirements and contradicting assessments of how to measure sustainable supply chains brought an additional level of uncertainty to MNC’s ESG initiatives in FDI. Companies are starting to realize they may not have fully assessed the impact of carbon emissions on its operations in other countries, specifically in the developing market.  Streamlining allowing for flexibility in the global ESG regulatory framework will be critical to ensuring sustainable investments increase and assist with countries in meeting their ESG goals. 

A way forward

To help meet the SDGs, the World Bank recently announced the creation of a roadmap that focused on three main objectives, including increasing private sector funding, improving country-level engagement and analysis, and establishing a global taxonomy for sustainable investment tools. UN Deputy Secretary-General Amina Mohammed recently warned that “the SDGs will fail without the private sector,” because private sector actors can “invest in the transitions necessary to accelerate development progress and get the SDGs back on track.” The private sector has not only the financial capacity, but also the commitment, to fuel sustainable investing, but faces barriers to keep up the momentum. The IMF and World Bank have an incredible opportunity to address the current ESG investing challenges. The World Bank roadmap is an important first step, but more will be needed to ensure globally consistent standards and data for ESG. The potential for greenwashing or indiscriminate exclusion of countries can be avoided by working with governments and ratings providers, and by improving country-level engagement to both align metrics and to integrate unique country risks in sustainable investing and supply chains. With many firms already leveraging IMF and World Bank data, creating a formal framework will encourage the expansion and scaling up of private sector ESG financing for regions in urgent need of funding.

Nisha Narayanan is a Non-Resident Senior Fellow with the GeoEconomics Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post How ESG investing can better serve sustainable development appeared first on Atlantic Council.

The post Mezran and Melcangi in Nouvelles du monde on President Saied’s Economic Dilemma appeared first on Atlantic Council.

The post Pavia in Il Foglio: Support from Washington to save Tunisia from default appeared first on Atlantic Council.

The NATO summit in Vilnius, Lithuania, in July is an opportunity for leaders to mitigate geoeconomic risk within the Alliance and in southeastern Europe in particular. Specifically, all allies should commit in the communiqué to the prompt adoption of investment screening legislation—particularly the Balkan nations of Albania, Bulgaria, Croatia, Montenegro, and North Macedonia, where legislation is largely absent. While the European Union (EU) is Europe’s lead institution on investment and trade issues, its technocratic approach has up to now failed to generate the necessary political will with all members of the Alliance to take investment security issues seriously. Putting the issue of investment screening on the wider transatlantic agenda will increase pressure on lagging allies to elevate investment security and accountability on NATO’s southeastern flank. The Alliance can look to how 5G security was put on the agenda a few years ago as a case study of how it can generate political will among allies to address gaps in national security that are notionally economic in nature.

Because the implementation of economic security regulations carries risks of abuse and corruption, NATO, the EU, and key member states from both organizations should support those nations in the development of inclusive and effective legislation that mitigates against economic risk while protecting the democratic process.

Economic security underpins military security

Members of the EU and NATO face a number of threats from authoritarian corrosive capital and critical economic dependencies. Whether originating from private or state-owned enterprises, unaccountable investments lack transparency, accountability, and market orientation. Corrosive capital largely originates from authoritarian states and exaggerates governance gaps to influence economic, political, and social developments in recipient countries. For example, authoritarian regimes, particularly China, use subsidies and other uncompetitive practices to invest in critical or other digital infrastructure that can have a dual military-civilian purpose, such as in port infrastructure in southeast Europe which could be used to transit military gear in support of NATO operations. Nontransparent investment flows, particularly in Bulgaria and the Western Balkans, undermine transparency and abet corruption. In the higher value-added sectors of the economy such as the thriving information and communications technology sectors in Bulgaria, unaccountable investments threaten the valuable intellectual property of Europe’s established firms and emerging start-ups alike. Last year, China weaponized Europe’s critical trade and supply chain dependency on the huge Chinese market to block Lithuanian imports to China, seeking to punish Vilnius for its foreign policy choices. Europe’s urgent transition in the last year away from Russian natural gas to renewable resources such as solar and wind power, which are dominated by China, risks replacing one set of strategic energy dependencies for another. 

To address these challenges, many European countries have developed new EU-wide investment screening regulations and the European Union has proposed legislation to counter economic coercion. Since 2020, EU member states are required to have an investment screening mechanism in place as part of the EU-wide investment screening coordination framework—but the details are left up to the individual countries, which are responsible for their own national security. 

NATO’s southeastern flank is the most vulnerable and least-prepared region to protect its economies from authoritarian corrosive capital. Montenegro has become famous for its “white elephant” Chinese-funded infrastructure projects. Croatia is host to the Chinese Southeast European Business Association and has actively courted Chinese investments in critical infrastructure, including ports and the EU-funded and China-built Peljesac bridge, the first example of subsidized Chinese firms beating out European firms for EU-funded projects in Europe. Bulgaria and North Macedonia have more pronounced links to unaccountable flows of Russian capital, including in the energy sector. 

Among these countries, only Croatia is in the early stages of exploring the development of an investment screening law, and it is doing so at a leisurely pace. Bulgaria is in an even earlier stage than Croatia, but has an opportunity with its new government to make progress. North Macedonia, Albania, and Montenegro also lack an investment screening mechanism, leaving NATO’s most vulnerable members and economies open to the risk of corrosive capital and unaccountable investment. These governments have largely failed to put investment security legislation and processes on the table because of a lack of political will. An initiative by key allies to put this issue on the table at NATO would help push lagging governments in southeast Europe to prioritize this issue. Yet, a push by NATO allies to close the investment security gap in southeast Europe should also be coupled with practical assistance to help those allies develop inclusive, transparent legislation on investment screening.

The risks of regulating economic activity in fragile democracies

Emerging markets in NATO’s southeastern flank, including Albania, Bulgaria, North Macedonia, and Croatia, face some of the greatest challenges to equipping themselves with the tools to protect their economies from national security threats. These allies face capacity and governance challenges that will require coordinated support from NATO, the EU, and key bilateral allies to help implement effective investment screening legislation.

First, the economies of southeastern Europe are among the least developed within NATO. As a result, most business leaders in these countries are desperate for any investment they can attract and are instinctively hostile to the idea of screening any investment. Coaxing the private sector into compliance with any relevant legislation will require an intentional and transparent process of policy dialogue between government and business to reassure business that legislation will not meaningfully harm the economy.

Second, these countries largely lack governmental capacity to effectively screen foreign investments, a highly technical process requiring competent bureaucrats armed with both economic and national security data and expertise. A related challenge is the need for the bureaucracy to maintain the confidentiality of proprietary corporate data during the screening process; leaks of government deliberations to tabloids are a pervasive problem in southeast European policymaking.

Third, the democracies of southeastern Europe are by and large low-trust societies with weak public-private dialogue and an often fragile rule of law, making effective and informed policy formulation a challenge. To ensure economic fairness and guard against regulatory abuse, any new tools allowing governments to regulate economic activity will need proper transparency, checks and balances, and oversight.

NATO and the EU face a conundrum in dealing with the geoeconomic challenges to southeastern Europe’s market, particularly in Bulgaria and Croatia, which are already in the European common market. On the one hand, failure to develop screening mechanisms and other tools in these economies leaves both the EU and NATO vulnerable to economic risk that could impact the wider single market. On the other hand, given the governance and capacity challenges in these countries, a rushed or opaque policy process could result in lack of awareness and compliance by the private sector or the emergence of unintended consequences such as barriers to legitimate competition.

What the EU, NATO, and Three Seas Initiative can do

To address these challenges, NATO, the European Union, and individual allies can play complementary roles.

Through its regulatory role, the EU should take the lead in supporting these countries in developing economic security legislation. The European Commission can provide technical support to help governments align their investment screening legislation with EU standards, particularly countries that are candidates for accession, such as Albania and North Macedonia. Meanwhile, the Organisation for Economic Co-operation and Development can provide technical support to member governments such as Croatia to help them understand the likely impact an investment screening law will have on its economy and competitiveness as an investment destination.

Because the EU leads on economic and trade issues, NATO’s role will involve helping allies assess national security implications of investment risk in dual-use economic assets that can have a military or other national security purpose. Here, planning groups within NATO’s Resilience Committee can provide guidance on how to ensure that screening mechanisms meet compliance with NATO’s baseline requirements for national resilience. In the interest of building political will, the NATO summit communiqué at Vilnius could set a deadline to have investment screening legislation in place by the seventy-fifth anniversary Washington summit next year.

Finally, select allies can provide bilateral mentorship and support for these southeast European nations on best practices for securing business buy-in and compliance with screening mechanisms. A system modeled after the Committee on Foreign Investment in the United States may not align with the needs, economic structure, or capacities of smaller countries in southeast Europe. Smaller allies such as the Czech Republic can advise southeastern European governments on the lessons learned from their experience, perhaps bringing in chambers of commerce and business associations to share their experiences on compliance with the law. 

The Three Seas Initiative, an informal gathering supported by the Atlantic Council and including twelve Central and Eastern European member states focused on north-south infrastructure development, could also help. It could serve as a venue for members to coordinate economic-security regulations to ensure wider harmonization of economic policy. Differences in investment security regulations across countries complicate the kind of cross-border investments that the Three Seas Initiative is designed to attract and finance. The Three Seas business forums in particular can serve as a channel for business associations and chambers from within the Three Seas region and neighboring countries in the Western Balkans. The forums offer a place for parties to share their experiences, challenges, and concerns about complexities caused by differences in screening legislation within the region and to formulate recommendations on how to minimize the impact on the investment environment.

Ultimately, the national governments of Croatia, Bulgaria, Albania, North Macedonia, and Montenegro will have to do the hard work themselves to adopt these best practices and craft successful legislation. Governments will need to consult with the business sector before legislation is drafted to help promote understanding of these processes, incorporate recommendations to streamline red tape, and raise awareness in the business community of critical threats that can allow them to adapt their internal due diligence. But this will require a balance to ensure that economic security is not traded away for the sake of economic development. Including civil society is also essential to ensure effective transparency and monitoring of review processes to make sure they are not used for corrupt purposes or overlook key threats.

As NATO heads into its seventy-fifth year, its member states and partner institutions need to adapt to new challenges. Robust investment screening across the whole of the Alliance will help strengthen NATO against economic weapons that are increasingly central to today’s conflicts.

Jeffrey Lightfoot is a nonresident senior fellow at the Scowcroft Center for Strategy and Security and is the Bratislava-based program director for Europe at the Center for International Private Enterprise.

John Kay is a program manager at the Center for International Private Enterprise and worked previously in the Balkans with the US Agency for International Development.

The post Authoritarian investment in southeastern Europe is a security threat. Here’s what NATO can do. appeared first on Atlantic Council.

The post Pavia quoted in Sole24Ore on the visit of Italian Prime Minister, Meloni, to Tunisia. appeared first on Atlantic Council.

The post Cryptocurrency Regulation Tracker cited in The Economist appeared first on Atlantic Council.

Policymakers who recently gathered in Washington, DC for the Spring Meetings of the IMF and World Bank highlighted the need for global progress on crypto-asset regulations. G20 finance ministers and central bank governors included global regulatory development on their list of priorities, as did the International Monetary and Financial Committee. Crypto regulations were discussed throughout the meetings, including in a session focused on the future of crypto-assets. 

The meetings made two things clear. First, the need for robust, globally coordinated crypto regulations is evident. And, second, policymakers face substantial challenges achieving that goal. Following on discussions held at the Spring Meetings, we used our Cryptocurrency Regulation Tracker to identify several of the major policy dilemmas facing policymakers and regulators.

Consumer protection rules are lagging behind other forms of regulation

Consumers participating in crypto-markets are exposed to considerable risk. Theft is increasingly common. Volatility, often fueled by speculation, is a defining feature of crypto markets. And misinformation and deceptive advertising make informed investing difficult. Despite the risks that consumers face, we found that only one-third of the countries studied had rules in place to protect consumers. Other countries may have legal protections that extend to crypto market participants, though the law is often untested or ambiguous. 

Fortunately, countries that do provide consumer protections are demonstrating a diversity of approaches. India, France, and others have helped consumers make better informed decisions by requiring that advertisers disclose risks associated with crypto-investing. In South Korea, crypto-asset service providers, such as exchanges and wallets, are required to obtain an information security certificate from the Korea Internet and Security Agency, decreasing the likelihood of theft. And many countries, including Australia and Japan, have rules in place to prevent and penalize deceptive conduct and fraud. While these examples demonstrate steps some countries are taking, the safety of crypto markets requires that policymakers redouble efforts to enact consumer protection regulations. 

Regulations to prevent another FTX-style collapse are a long way off

Centralized exchanges like FTX and Binance play a critical role in the crypto ecosystem. By allowing individuals to participate in “off-chain” transactions involving crypto-assets, they dramatically reduce the barriers to entry posed by more technically complex “on-chain” transactions. The substantial gains made in market capitalization and adoption would be unlikely absent centralized exchanges.

But centralized exchanges that perform multiple functions pose risks that regulators must address. Many exchanges are not sufficiently transparent about their operations, finances, or governance, leaving investors in the dark on key matters. Some companies are taking steps to address this problem by disclosing “proof of reserves”, a transparent accounting of a company’s assets and liabilities. While more than half of the countries in the tracker have licensing or registration rules, these do not typically include disclosure requirements. 

Centralized exchanges may misuse customer funds. Unlike in traditional finance, where customer funds are subject to certain protections, centralized exchanges typically face either nonexistent or less stringent regulations. The Cryptocurrency Regulation Tracker includes only two examples of a specific requirement that crypto companies segregate customer funds, placing a firewall between customer money and proprietary trading. The European Union’s Markets in Crypto-assets framework, which became law last month, has specific rules that wall off customer funds from proprietary trading. The US Securities and Exchange Commission is considering a similar move.

In some cases, global exchanges may fall outside national or regulatory borders. This leaves policymakers incapable of performing basic oversight, as was the case with FTX in the United States. Policymakers have yet to achieve coordinated global action and are continually confounded by crypto companies that evade—intentionally or otherwise—traditional regulatory definitions. Bringing crypto activity within the regulatory perimeter remains a key challenge. 

Our research shows that more needs to be done to prevent the next FTX. Fortunately, that debacle has propelled policymakers and regulators to fill this perilous gap. 

Low- and middle-income countries lag advanced economies in regulatory development, but not in rates of crypto adoption 

The Cryptocurrency Regulation Tracker considers four categories of regulation: taxation, anti-money laundering, consumer protection, and licensing. Of the advanced economies we reviewed, 64% have regulations in each of these categories. Only 11% of the middle income countries have rules in all four categories, and none of the low-income countries do. These findings identify a clear trend: low- and middle-income countries are adopting crypto-regulations more slowly. 

Limited regulatory development, however, has not slowed adoption. In fact, our research found virtually no relationship between crypto-regulation and adoption rates. Six of the ten countries with the highest rates of adoption (according to Chainalysis) have in place either a partial or general ban on crypto-assets. It is worrying that some low- and middle-income countries, who may be vulnerable to crypto-induced shocks, have active crypto-markets with few regulations. 

The widening regulatory gap between countries is a critical challenge for international financial institutions and standard-setting bodies. Patchwork, uncoordinated global regulations present opportunities for regulatory arbitrage. Companies may consider issuing new crypto-assets from jurisdictions with few or no guidelines and selling those assets to investors around the world—even in countries where such sales are technically illegal. In the short-term, such activity could hurt consumers and facilitate illicit activity. In the longer-term, it could present a meaningful financial stability risk. 

In recent remarks at the Atlantic Council, World Bank President David Malpass urged regulators to make global standards “accessible” to countries with lower state capacity. Indeed, the International Monetary Fund, Financial Stability Board, and others must do the tough work of both establishing global standards and providing technical assistance where needed. 

Regulators around the world face multiple challenges. They must protect customers and put in place safeguards to prevent the next FTX-style collapse, all while coordinating across diverse jurisdictions. And they have a long way still to go.

To keep up with this rapidly evolving topic, follow the GeoEconomics Center’s Cryptocurrency Regulation Tracker.

Cryptocurrency Regulation Tracker

Cryptocurrencies may significantly alter financial structures and transform the next generation of money and payments. Governments around the world are looking to create regulations to prevent the harms caused by cryptocurrencies while encouraging the innovative capabilities of cryptocurrencies. We analyze how 45 countries have regulated cryptocurrency in their jurisdictions.

Greg Brownstein is a Bretton Woods 2.0 Fellow and research consultant with the GeoEconomics Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post <strong>Three challenges in cryptocurrency regulation</strong> appeared first on Atlantic Council.

This shift in market sentiment has whittled away the flow of capital into China, underlining how de-risking has become a bottom-line imperative as much as a diplomatic strategy. And it does not bode well for China amid growing anxiety about the country’s economic prospects. 

China’s economy has failed to rebound as expected from Zero-Covid policies, and it faces profound structural challenges: A rapidly aging workforce and slow productivity growth; widening income inequality; and a crippling property crisis. All this adds up to a difficult straits in which local governments and many companies can’t pay their bills. Even though China doesn’t need foreign capital like it did a generation ago, foreigners’ reluctance to invest will reverberate through the economy over time. 

Fund managers—especially those with investment strategies focused on the long-term—are concerned about the political uncertainty created by Beijing’s regulatory crackdown on leading private sector conglomerates and heavy-handed pressure on Western companies. Now the Biden administration is preparing to restrict the flow of US venture capital and private equity to Chinese startups developing sensitive technologies—a step many investors worry is a harbinger of more sanctions to come. Western manufacturers are also taking first steps to leave the country, or at least to implement “China+1” strategies. 

Meanwhile, Beijing has been undertaking its own form of de-risking by imposing strict regulations that have choked off the number of Chinese companies launching initial public offerings (IPOs) in the US. China’s bureaucrats are concerned about exposing secrets supposedly contained in the vast troves of data controlled by companies seeking IPOs. Instead, the government is making it easier for these companies to list in Shanghai and Shenzhen. More IPOs have been launched in those markets over the past year than in any other market—but with less long-term, foreign capital to offset the share-price volatility that comes from China’s army of retail investors. 

The bottom line for many foreign fund managers is that the risk of investing in Chinese securities has soared over the past year and the returns have not kept up. Those returns are out of reach because of the country’s economic doldrums and anemic corporate profits. As a result, many pension funds and other large institutions have stopped buying China altogether. Instead, they are shifting capital to more promising emerging markets like India, where the economic outlook is brighter and politics less of a worry.  

The turn away from Chinese bonds is also a response to the efforts to contain US inflation. As the US Federal Reserve has raised interest rates—and China’s central bank has maintained a loose monetary policy in the face of slow growth—10-year US Treasuries have offered better yields than comparable Chinese bonds. At the same time, the renminbi has weakened against the dollar, potentially making investments in China even less profitable.  

Chinese stocks did well during the first year of Covid as China’s exporters rushed to feed the world’s demand for pandemic supplies. But after hitting peaks in early 2021, the shares popular with investors in New York and Hong Kong fell for 20 months. A key reason was Beijing’s regulatory crackdown on tech platforms like Alibaba Group and ride hailer Didi Global, which Chinese regulators forced to delist from the New York Stock Exchange immediately after a successful IPO in June 2021. Foreign investors returned to buying in late 2022 in expectation of an economic rebound as Beijing loosened its harsh Zero-Covid policies. But by Spring they had returned to selling amid disappointment with the Chinese government’s policies, skepticism about Beijing’s belated promises of support for companies that had been targeted in the crackdown, and worries about worsening US-China relations. 

This evolution is clear from the performance of the Nasdaq Golden China Index, which tracks Chinese companies listed in the US, and the Hang Seng China Enterprises Index in Hong Kong. 

The loss of confidence among US investors outweighed what might have been the salutary effect of last year’s resolution of a dispute between Washington and Beijing over the auditing standards of Chinese companies on Wall Street that had threatened to delist those firms. Trading in some of those shares also has been affected as fund managers shift their investments to some companies’ parallel listings in Hong Kong in anticipation of future delisting—another aspect of the concern about US-China tensions. By the end of March, 53 percent of Alibaba’s “tradeable” shares were registered in Hong Kong, up from 38 percent at the end of 2022.  

Some foreign fund managers remain committed to Chinese stocks, especially hedge funds. But they aren’t necessarily the stable, long-term investors the Chinese government seeks.  

Beijing is not standing idly by: It continues to provide new avenues for foreign investors, most recently opening a channel for them to hedge bond investments and licensing major Western investment banks to operate wholly-owned fund management businesses catering to domestic Chinese investors. But there is a sense among foreign firms that China will prove less profitable than they once hoped. 

Then there are the funds that specialize in early-stage investing: Venture capital (VC) and private equity investors (PE) who provide startups with seed money and help bring them to market. These investors have played a significant role in the development of many leading Chinese technology companies. For example, American VC firms and other foreign investors made 58 investments in China’s semiconductor industry from 2017 to 2020, and China-based affiliates of Silicon Valley VCs provided capital to 67 chip-related ventures in 2020 and 2021. 

But since the Biden administration began exploring restrictions on outbound investment, the pace of Chinese investments from abroad by both groups has declined. The share of VC deals in China that include non-Chinese investors dropped to 15.1 percent last year from 2021, the lowest level since 2017. Meanwhile, PE investments in China by American investors declined 76 percent to $7.02 billion last year from $28.92 billion in 2021.  

While the China affiliates of some VCs continue to raise funds, the imminent White House executive order is expected to continue cutting into this category of investment. Combined with recent Biden administration restrictions on sales to China of advanced semiconductors and cutting-edge chip-making gear, the message to all classes of investors will be clear: Putting money in China is going to become riskier, and de-risking is only going to become more commonplace. 

Jeremy Mark is a senior fellow with the Atlantic Council’s Geoeconomics Center. He previously worked for the IMF and the Asian Wall Street Journal. Follow him on Twitter: @JedMark888.

The post Investors have been “de-risking” from China for years appeared first on Atlantic Council.

In this edition of the Global Sanctions Dashboard, we cover:

• New sanctions packages against Russia released ahead of the G7 Summit.
• How the United States is tackling export controls circumvention and what should improve moving forward.
• The enforcement and effectiveness of the oil price cap.
• The failure of the US sanctions policy towards Sudan, and how to fix it.

New sanctions packages against Russia released ahead of the G7 Summit

The Ukrainian intelligence assessment from 2022 indicated that forty out of fifty-two components recovered from the Iranian Shahed-136 drone that was downed in Ukraine last fall had been manufactured by thirteen different American companies, while the remaining twelve were made in Canada, Switzerland, Japan, Taiwan, and China. The case revealed that it was not enough to impose sanctions and export controls on Russian defense companies. Not only was Iran providing drones to Russia, but also certain entities and individuals in countries such as Switzerland and Liechtenstein have procured materials on Russia’s behalf. This is why the United States released a new sanctions package ahead of the G7 summit, targeting a much wider international network of Russia sanctions and export controls evasion. 

Finland, Switzerland, Cyprus, United Arab Emirates, India, Singapore—these are just a few locations associated with individuals and entities included in the Treasury Department’s newest designations against Russia. Entities and individuals located in these countries have aided Russia’s circumvention efforts or provided materials for Russia’s military procurement. Among the sanctioned individuals are Swiss-Italian businessman Walter Moretti and his colleagues in Germany and India, who have sold advanced technology to Russian state-owned enterprises. Liechtenstein-based Trade Initiative Establishment (TIE) and its network of two companies and four individuals have been procuring semiconductor production equipment for sanctioned Russian entities since 2012. 

Along with the United States, the United Kingdom also imposed sanctions against eighty-six individuals and entities from Russian energy, metals, financial, and military sectors who have been enhancing Russia’s capacity to wage the war. Additionally, the European Union (EU) is developing its eleventh package of sanctions which will reportedly, for the first time, target Chinese entities facilitating Russia’s evasion efforts. Coordinating the designation and enforcing processes among the G7 allies will be key in synchronizing the targeting of Russia’s evasion and procurement networks.

Export controls circumvention: How the US is tackling it and what should improve moving forward

While sanctions aim to cut entities and individuals procuring technology for the Russian military out of the global financial system, export controls are designed to prevent them from physically acquiring components. G7 allies have levied significant export controls on Russia, but enforcing export controls is easier said than done. Third countries from Russia’s close neighborhood have stepped up to fill Russia’s technology shortages caused by other countries complying with export controls. Central Asian and Caucasus countries had a significant uptick in exports of electronic components to Russia, while Turkey, Serbia, and Kazakhstan have been supplying semiconductors to Moscow. Even if exported electronic components are not designed for military application, Russians have been able to extract semiconductors and electronic components for military use even from refrigerators and dishwashers. The sudden boost in electronic equipment exports from Central Asia and the Caucasus to Russia can only be explained by Russia’s efforts of repurposing them for military use. 

In response to Russia’s efforts to obtain technology by all means possible, the US Departments of Commerce and Justice have jointly launched the Disruptive Technology Strike Force. The goal of the Strike Force is to prevent Russia and adversarial states such as China and Iran from illicitly getting their hands on advanced US technology. The Strike Force recently announced criminal charges against individuals supplying software and hardware source codes stolen from US tech companies to China. The Strike Force embodies the whole-of-government approach the United States has been taking in investigating sanctions and export controls evasion cases. The prosecutorial and investigative expertise of the Justice Department, coupled with the Treasury’s ability to identify and block the sanctions evaders from the US financial system, will amplify the impact of the Commerce Department’s export controls and enhance their investigations and enforcement.  

The US Department of Commerce has also teamed up with Treasury’s Financial Crimes Enforcement Network (FinCEN) to publish a joint supplemental alert outliniing red flags for potential Russian export controls evasion that financial institutions should watch out for and report on, consistent with their compliance reporting requirements. The red flags include but are not limited to:

• Payments for dual-use goods to companies located outside of the Global Export Controls Coalition (GECC) countries. 
• A new customer who trades in the nine Harmonized System (HS) codes, is located outside of the GECC countries and was incorporated after February 24, 2022. 
• A consumer who refuses to provide details to banks about end users or company ownership. 

Providing information to the public in the form of alerts and advisories is an effective step to increase awareness, financial institution reporting, and compliance with Western sanctions and exports controls. The Disruptive Technology Strike Force should consider issuing a multilateral advisory on export control evasion with G7 allies to bring in foreign partner perspectives, similar to the multilateral advisory issued in March on sanctions evasion by the Russian Elites, Proxies, and Oligarchs Task Force (REPO)

Regarding third-country intermediaries suspected of supplying Russia with dual-use technology, G7 allies should prioritize capacity building and encouraging political will in these countries to strengthen sanctions and customs enforcement. Building up their capacity to monitor and record what products are being exported to Russia could be the first step towards this goal. For example, Georgian authorities returned goods and vehicles destined for Russia and Belarus in 204 cases. However, registration certificates did not identify the codes of returned goods in fifty cases, and clarified that the goods were sanctioned only in seventy-one cases. Developing a system for identifying controlled goods and making the customs data easily accessible to the public could both salvage Georgia’s reputation and enhance export control enforcement against Russia.

The enforcement and effectiveness of the oil price cap

The US Department of the Treasury recently published a report analyzing the effects of the oil price cap, arguing that the novel tool has achieved its dual objective of reducing revenue for Moscow while keeping global oil prices relatively stable. A recent study by the Kyiv School of Economics Institute backs up this statement with detailed research of the Russian ports and the payments made to Russian sellers. However, Russian crude oil exports to China through the Russian Pacific port of Kozmino might be examples of transactions where the price cap approach does not hold.

In response, the Department of the Treasury warned US ship owners and flagging registries to use maritime intelligence services for detecting when tankers are disguising their port of call in Russia. Meanwhile, commodities brokers and oil traders should invoice shipping, freight, customs, and insurance costs separately, and ensure that the price of Russian oil is below 60 dollars. 

Despite China’s imports of Russian crude oil, the world average price for Russian crude oil in the first quarter of 2023 was 58.62 dollars, which supports the claim about the success of the oil price cap, at least for now. Notably, Russia’s energy revenues dropped by almost 40 percent from December 2022 to January 2023, likely in part due to the price cap combined with lower global energy prices.

Beyond Russia: The failure of US sanctions policy towards Sudan, and how to fix it.

While the world has been focused on the G7 summit, the crisis worsened in Sudan. In April 2023, President Biden issued Executive Order 14098 (EO 14098) authorizing future sanctions on foreign persons to address the situation in Sudan and to support a transition to democracy and a civilian transitional government in Sudan. The use of sanctions to support policy goals in Africa is not new. In the case of EO 14098, policymakers seek to use future sanctions on individuals responsible for threatening the peace, security, and stability of Sudan, undermining Sudan’s democratic transition, as well as committing violence against civilians or perpetuating other human rights abuses. 

Much has been written and studied about the effectiveness of sanctions programs in Africa with many programs suffering from being poorly designed, organized, implemented, or enforced. Sudan faced statutory sanctions from its designation as a State Sponsor of Terrorism from 1993 to 2020 and US Treasury sanctions from 1997 to 2017 both of which produced limited results due to ineffective enforcement and maintenance of the program. A near-total cut-off of Sudan from the US financial system pushed Sudan to develop financial ties beyond the reach of the US dollar.

Sanctions in Sudan can be useful if applied in concert with more concrete action. US policymakers must elevate Sudan on their priority list and engage their counterparts at sufficiently senior levels in the United Arab Emirates (UAE), Egypt, Saudi Arabia, Turkey, and elsewhere to encourage them to apply pressure on the Sudanese generals. This could be done by freezing and seizing their financial, business, real estate, and other assets in these relevant countries. Cutting off those links will impede the two generals’ ability to fight, resupply weapons, and pay their soldiers, which could force them back to the negotiating table.

Kimberly Donovan is the director of the Economic Statecraft Initiative within the Atlantic Council’s GeoEconomics Center. Follow her at @KDonovan_AC.

Maia Nikoladze is the assistant director at the Economic Statecraft Initiative within the Atlantic Council’s GeoEconomics Center. Follow her at @Mai_Nikoladze.

Benjamin Mossberg is the deputy director of the Atlantic Council’s Africa Center.

Castellum.AI partners with the Economic Statecraft Initiative and provides sanctions data for the Global Sanctions Dashboard and Russia Sanctions Database.

Global Sanctions Dashboard

The Global Sanctions Dashboard provides a global overview of various sanctions regimes and lists. Each month you will find an update on the most recent listings and delistings and insights into the motivations behind them.

Explore Here

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Global Sanctions Dashboard: US and G7 allies target Russia’s evasion and procurement networks appeared first on Atlantic Council.

However, it’s possible that investors would try to buy more US Treasuries in the wake of default. Why? Because there is no viable alternative. Think back to the start of the Global Financial Crisis or COVID-19. In both situations, the world scooped up US bonds. That’s because there is nothing else like US Treasuries.

In a crisis, investors search for safety. Safe assets have a high likelihood of payout and can be traded easily. In practice, that usually means bonds issued by a handful of stable governments in advanced economies. The problem for any investor looking for safety in the wake of a US default is that the US Treasury market is much larger than any similarly-rated government bond market.

Would the world turn to German bunds, the only other AAA-rated sovereign debt in the G7? Maybe, but as the chart above illustrates, their market is less than 1/10th of the size of the US Treasury market. And German fiscal rules make it basically impossible for them to ever catch-up.

Where else to go? The UK gilt market? Beyond its small scale, you will recall the UK had its own credibility crisis just last year.

China? If you’re looking for a reliable, transparent, liquid market where you can turn your holdings into cash quickly without question, China is not it. 

Japan seems like a reasonable option until you realize the amount of Japanese government bonds (JGBs) available is overwhelmingly influenced by the central bank’s intervention in its bond market.

Where else could investors turn? They could hold more cash, but the opportunity cost of doing so has risen in the form of higher interest rates. They could look for relatively safe private sector assets, like the bonds of large, stable firms. But as the crisis of 2008-09 showed, even highly-rated private sector securities can be risky in a crisis.

There simply are not enough safe assets available for investors to move off of Treasuries. This is one reason why flirting with a default is so maddening. The US government issues something the rest of the world desperately wishes it had.

In the immediate aftermath of a default, Secretary Yellen may calm the Treasury market by promising to continue to pay interest on debt even as other bills go unpaid. But no one should mistake that for a solution. There would be massive fallout both for the US and global economy in this scenario. The bottom line is that in a default, even if US Treasuries have a short-term win, everyone—including the US—will still lose.

Josh Lipsky is the senior director of the Atlantic Council’s GeoEconomics Center and a former adviser at the International Monetary Fund.

Phillip Meng contributed research to this piece. A version of this piece appeared in the GeoEconomics Center’s private Sunday night newsletter  Guide to the Global Economy. To subscribe to the newsletter please email sbusch@atlanticcouncil.org.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post There is no alternative to US Treasuries appeared first on Atlantic Council.

Historically, US consumers used checks to make payments directly from their bank accounts, but check payments do not translate to online payments. Today, US consumers are left with a gap in their payment options: they cannot pay directly from their bank accounts (as allowed by a check), and real-time payments can only be made through expensive third-party credit cards. The lack of a real-time digital payments network holds the US back: It creates delays and risks for consumers and businesses and ties up capital needlessly.

The US has some catching up to do. Many countries in Europe stopped issuing paper checks more than two decades ago, transitioning instead to an electronic payments network. The United Kingdom introduced instant payments in 2008. The Single Euro Payments Area (SEPA) was launched in 2017, allowing instant payments among 36 countries using a unified framework for direct bank payments, including cross-border transfers. Globally, 79 countries have already implemented at least one instant payment network.

This year, the US will take a major step toward faster payments when the Federal Reserve launches its planned FedNow payment network. But even after FedNow launches, the US will still have a ways to go before consumers can access instantaneous digital payments.

Faster payments in the US

The US was originally at the forefront of electronic payments. In the 1970s, it introduced the Automated Clearing House (ACH) for processing electronic payments. This initiative happened because a group of California bankers became concerned about the growing volume of paper checks overwhelming the processing equipment and the technology to clear the checks.  ACH became—and still is—the method for issuing payroll, vendor payments, and other direct deposits.

While the ACH network made electronic payments possible within the US, it is far from instantaneous. ACH settlements typically take several business days from the time they’re initiated. ACH transactions are processed in batches, either at the beginning or end of the day, or as several batches throughout the day, necessitated by the extremely robust but 60-year old COBOL mainframe systems on which ACH runs. The ACH network moved $77 trillion in 2022.

In 2016, the ACH Network introduced Same-Day ACH which settled transactions within the same business day. Still, same-day ACH falls short of instant payment processing. Wire transfers are another payment option, with real-time transfer capabilities through the FedWire system. However, wire transfers need to be submitted during FedWire operating hours. Wire transfers typically support critical business transactions involving large sums rather than everyday payments between consumers and companies, and often incur significant fees.

A few consumer-friendly options have emerged, such as the RTP network. Governed by some of the largest banks in the US, the RTP network offers real-time payment processing for financial institutions. Unlike ACH, however, RTP only has the ability to credit payments to an account (“push payments”), whereas ACH also has the ability to debit payments from an account (“pull payments”).Meanwhile, checks are still a regularly used form of payment for consumer and business transactions in the US. In 2003, Congress passed The Check Clearing for the 21st Century Act (Check 21), as a way for banks to accept an electronic substitution (image) of a check instead of the original. The purpose was to “foster innovation in the payments system” according to the Federal Reserve, but is still no more than a patch on an antiquated technology.

FedNow: One step closer to real-time payments

In 2019, the Federal Reserve announced its plans for the FedNow Service, the U.S. attempt to create a European-style network of real-time payments. As a complement to the ACH Network, FedNow (with an initial launch planned for July 2023) will offer instant payments between bank accounts. Transfers will take mere seconds instead of hours or days that ACH and Same-Day ACH offer. And, unlike FedWire, FedNow will be available 24/7. FedNow will be governed by the Federal Reserve instead of a private banking association. Like the RTP network, FedNow will have transaction fees of only a few cents per transaction, which makes it cost-effective. Initially, FedNow will have a cap of $500,000 while the RTP network has a limit of $1 million per transaction. For now, FedNow also only supports domestic “push payments”  but not “pull payments,” so it is still missing half of the equation that ACH enables.

The key variable for these real-time payment solutions is “participating financial institutions.” The RTP network has close to 280 participating financial institutions, including some of the largest banks in the country, but with nearly 10,000 banks and credit unions in the US, this offers far from universal coverage. FedNow is only just beginning its rollout and, again, financial institutions have to opt to implement FedNow. Consumers will not be able to access FedNow directly, and can only access it if their bank opts in. Eventually, FedNow is expected to have interoperability with ACH, which could broaden its reach and perhaps get the US closer to instant payments.

Financial institutions, even if they opt in to FedNow, will still have to figure out how to make it available to their customers. FedNow only operates as a payment rails system; access for consumers needs to be provided by the financial institution through their online banking or a third-party app. Adoption among the general population may be slow and limited as a result. Also, the lack of support for “pull payments” means that instant payments directly from a consumer’s bank account—as well as other solutions requiring “pull” capability—are still not possible.  For these reasons, FedNow will also not work as payment rails for the P2P space. Finally, there are legitimate concerns that FedNow does not adequately protect against fraud, as it does not provide a solid method for recalling erroneous or fraudulent payments that is available when making payments by wire.

FedNow will likely change the face of bank to bank payments in the US, particularly with respect to business-initiated payments. But the FedNow system as currently imagined falls short of being a fully-integrated real-time payments network supporting a broad range of instant consumer, business and international payments use cases (both “push” and “pull”) that Europe has proven is possible. 

The US may still be waiting for its true solution to real-time payments.

Piret Loone is a contributor to the GeoEconomics Center and the General Counsel and Interim Chief Compliance Officer at Link Financial Technologies.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post <strong>Can FedNow bring the US closer to real-time payments?</strong> appeared first on Atlantic Council.

SWIFT was founded in 1973 with 239 original members and over the years has grown to incorporate 11,696 banks sending more than 44 million messages around the world every day. But the core idea has stayed the same: Banks need a uniform and standard way to communicate with each other about transactions, and SWIFT is the answer. Every member gets a unique code—with details about country, location, and even bank branch. When a bank wants to transfer money to another bank, it simply enters the code through the SWIFT network, tells the other bank the amount, and then the actual money changes hands.

But here’s the rub—SWIFT is only a messaging service. It does not provide bank accounts or hold funds for banks in any capacity. The banks actually transfer the funds through a different entity. In order to send money across borders, individuals usually need to use a trusted network of banks, which settle transactions through a series of mutually held accounts. Think of SWIFT like a very elite Gmail, but once you tell your friend you want money, they have to switch over to Venmo to actually pay you. That’s why ‘banning’ a bank from SWIFT does not mean that the institution cannot get money from other banks. It just makes it more complicated and costly to do so.

In 2020, global businesses transferred approximately $23.5 trillion across borders—and it cost them over $120 billion to process the transactions. That’s like paying a tax the size of Morocco’s entire gross domestic product. Plus, these payments often take days to settle. It’s a lot of money for slow service, and that cost gets passed on to consumers.

How banks move money around the world

Interactive graphic by Sophia Busch, Alisha Chhangani, and Nancy Messieh.

What if SWIFT helped build something faster and cheaper? What if you could create a network that could combine both messaging and settlement and become a one-stop shop for international payments? That’s what China has been working on since 2016 with its Cross-Border Interbank Payments System, or CIPS, and most recently with its wholesale central bank digital currency (CBDC) experiment, the mBridge Project.

Both the CIPS and mBridge projects can be utilized for cross-border wholesale (meaning bank-to-bank) purposes. Importantly, the mBridge project is a cross-border CBDC initiative. The idea for both is that large sums of money could be sent between banks internationally, without using SWIFT for messaging or the dollar-based payments clearance hub, the Clearing House Interbank Payments System (CHIPS), for settlement. Already Hong Kong, the United Arab Emirates, and Thailand have partnered with the People’s Bank of China on the mBridge project, and in October 2022, they settled twenty-two million dollars across borders. This was the first successful test of cross-border bank-to-bank digital currency involving real money. As Atlantic Council research on CBDCs has shown, mBridge is just one of more than a dozen wholesale CBDC projects globally, many of which accelerated after Russia’s invasion of Ukraine and the Group of Seven (G7) sanctions response. Over time, if these systems are successful, they could create alternative financial transfer networks and provide a useful conduit for countries aiming to avoid the bite of Western sanctions.

SWIFT is not sitting idly by. The technology teams at its headquarters outside of Brussels are piloting their own cross-border CBDC system, partnering with major private banks and central banks including the Banque de France and the German Bundesbank. They are also experimenting with new, faster types of global transfers between banks. But transforming SWIFT from a messaging system to a new cross-border settlement system that can handle all types of assets (both traditional and digital) is going to take years and millions of dollars. Where to start?

The first step is for the board that governs SWIFT to give it the green light to innovate. As SWIFT members are eager to point out, they are a “private cooperative” and answer to their shareholders. But it’s not so simple. SWIFT is overseen by the National Bank of Belgium and the European Central Bank alongside the central banks of Italy, the Netherlands, Switzerland, Sweden, Canada, Japan, the United Kingdom, and the United States.

These countries have responsibility for providing SWIFT with strategic guidance and helping direct its technology planning. But so far no central bank has publicly come out in support of a major modernization effort. That’s a mistake.

It is understandable for Western central banks to feel sanguine about SWIFT’s current dominance. After all, the vast majority of global transactions currently touch SWIFT at some point. But look closer and you can see the ground shifting. Last month, Bangladesh agreed to pay a Russian company that is helping the country build a nuclear power plant in Rooppur. What’s interesting is how it is paid. Since Russian banks are largely banned from SWIFT, Bangladesh used a bank account at a Chinese bank that transferred yuan to Russia through CIPS. 

Bangladesh is not alone. Transaction volume on CIPS has more than doubled since 2020, and the number of direct and indirect participants in its network has also increased. More and more of these transactions will develop outside of SWIFT, and governments will understand less and less of what’s happening. Part of the motivation is geopolitical, given the way the dollar and euro are being weaponized against Russia. But a large part of it is simply technological: There are faster and cheaper ways to exchange money between countries, and if SWIFT does not figure out how to do it, someone else will.

Even if it is somewhat late to the game, SWIFT has a massive incumbent advantage. With its network of more than eleven thousand banks, SWIFT can build on a system that the world already relies upon instead of creating something new from scratch. China and Russia have to build a rival from the ground up and that takes time. SWIFT’s network is familiar and trusted: Think of it like an individual customer—why switch to a whole new bank if my current one is going to offer all the same features? If there are disputes, or mistakes, they can be settled in European courts.

Plus, SWIFT has something no one else can offer. It is the gateway to interacting with banks in New York, London, Tokyo, Paris, and Frankfurt. The argument for the new SWIFT is simple: If you want to be interoperable with the dollar, the euro, the pound, and the yen—which together are used in more than 85 percent of global transactions—this is the place to do it. If the G7 works in tandem to set technical and regulatory rules of the road for this new network it will, over time, become the de facto global standard, just like the original SWIFT of the 1970s.

The new SWIFT will have to do multiple things at once: communicate and settle between thousands of banks all over the world, find a way to transfer traditional commercial bank money as well as money on a blockchain, and do it all before a network of regional systems springs up to challenge its effectiveness and increase the fragmentation of money and finance.

Doing this right requires a massive investment in innovation from the Western banks that guide SWIFT. The United States is going to have to spend money and bring its own technological solutions to the table. There are major risks involved with faster settlements, including the need for adequate liquidity to complete the transaction, and it will require new regulations to ensure the system is trusted and secure. The recent Silicon Valley Bank crisis, accelerated by a social media–fueled bank run, should provide a lesson on the perils of moving money quickly in the digital age. And while SWIFT rebuilds, it will need to maintain its current operations. Remodeling a house while living in it is a tricky proposition.

But the bigger risk is doing nothing. This year SWIFT will turn fifty. For decades, SWIFT was the pace setter in the race for the future of money. Its technology connected the world’s financial institutions and helped ensure a system with Western protections on rule of law, privacy, and anti-money laundering provisions became the global standard. But all that is changing. If the United States and its allies want to create and promote the technological standard for the decade ahead while ensuring the effectiveness of sanctions, it’s time to start moving, well, more swiftly.

Josh Lipsky is the senior director of the Atlantic Council’s GeoEconomics Center and a former IMF advisor.

Ananya Kumar is the associate director of digital currencies at the Atlantic Council’s GeoEconomics Center.

The post Not so fast: The case for a new SWIFT appeared first on Atlantic Council.

Over the past year, bank deposits fell by almost $1 trillion while assets under management (AUM) of the MMFs increased by $700 billion. MMFs were growing before the banking turmoil, too: AUM has increased by $1.7 trillion since the beginning of 2020, to $5.7 trillion at present. Since MMFs largely invest in US Treasury bills, their status as a safe and attractive alternative to bank deposits would be threatened if the national debt ceiling stalemate cannot be resolved in time. A debt ceiling breach would put in doubt the government’s ability to meet its obligations, as soon as June 1. This is known as the X-date when the Treasury Department will have exhausted all extraordinary measures to avoid breaching the $31.4 trillion debt ceiling. Even if the stalemate is resolved at the last moment, as market participants currently expect, the increase in the probability of government default would elevate uncertainty and further unsettle financial markets which have already been under stress. The tail-end risk of a messy and prolonged debt ceiling stalemate is higher this time around than previously—and money markets will be the first to react if a deal isn’t reached in time.

Why money market funds are at risk

MMFs are vulnerable to disruptions in the Treasury market since they hold a lot of Treasury bills. In particular, government MMFs—with $4.4 trillion in AUM—split their portfolios almost evenly between Treasury bills and lending to the Fed via the Overnight Reverse Repo facility. Under this facility, MMFs can lend money to the Fed on an overnight basis, taking US Treasury securities as collateral and agreeing to sell them back at predetermined rates. The Fed reserve repo facility has grown substantially in recent years, reaching $2.2 trillion in volume at present.

As the X-date approaches, one-year US sovereign Credit Default Swap (CDS) spreads (equivalent to the insurance premiums investors pay for protection against default) have jumped to more than 160 basis points—a record high compared to less than 20 basis points during normal times. That exceeds the CDS spreads for Mexico, Brazil and Greece. Investors have also avoided T-bills maturing right after the X-date, pushing up their yields. For example, at the latest auction on May 4, yields on one-month T-bills maturing on June 6 jumped to 5.76 percent, or 240 basis points higher than two weeks ago. Such a sharp and abrupt increase in yields has reduced the prices of fixed income instruments like T-bills, leading to mark-to-market losses at MMFs. Depending on their portfolio composition and risk management practices, some MMFs could suffer losses noticeable enough to discomfort their clients who expect stable values of these funds.

Furthermore, if the debt ceiling is not raised in time to avoid default, the US credit rating would be downgraded to Restricted Default (RD) and affected Treasury securities would carry a D rating until the default is cured. Even if the government prioritizes the servicing of its debt ahead of other obligations to avoid default—a politically controversial move—that would not be consistent with an AAA rating. One major agency, S&P, already downgraded the US in 2011.

In short, possible mark-to-market losses and credit downgrades of Treasury securities, the main assets held by MMFs, would generate anxiety among MMF clients, probably prompting some to move their money elsewhere. (Much of it might flow to the top banks, further accelerating the consolidation of the US banking system.) While any outflow could be dampened to some extent by the gating arrangements and liquidity fees employed by MMFs to manage the outflow in an orderly way, this would nevertheless heighten uncertainty and a sense of nervousness in financial markets already struggling to cope with the regional banking crisis, high interest rates, and a credit crunch. Adding a run on MMFs to heighten market turmoil might trigger a more severe recession than hitherto expected. For that reason, the negative financial and economic impacts of the current debt ceiling stalemate could be more substantial than those of the previous episodes in 2011 and 2013.

Uncertainty at just the wrong time

MMFs can respond to the uncertainty surrounding the status of Treasury bills after the X-date by lending more to the Fed through the reverse repo facility, whose daily volume could rise substantially in the weeks ahead. However, the more MMFs lend to the Fed, the more liquidity is being withdrawn from the financial system, compounding the effects of Quantitative Tightening (QT) which the Fed has been implementing since June 2022 to reduce its holding of government securities by $95 billion per month. This would make it more difficult to assess the overall effects of the Fed’s tightening policy stance—both for the Fed itself and for market participants, elevating uncertainty about future economic prospects.

The political wrangling over the national debt ceiling has heightened uncertainty at the wrong time and is helping to raise the odds of a severe recession. Beyond the near-term outlook, the recurrence of the debt ceiling “mini crises” would erode the reliability, predictability, and trustworthiness of the US government—possibly causing it to eventually lose its AAA rating and raising its funding costs. More fundamentally, the practice of using the debt ceiling as a political tool to change or terminate federal programs approved by previous Congresses reflects bad governance in the US—notwithstanding the fact that the US public debt/GDP ratio is too high and needs to be reduced over time. The inability of the US to adopt a sustainable fiscal policy in an orderly manner will exact an increasingly noticeable cost by diminishing the efficiency and credibility of the US government, with negative implications for the whole economy.

Hung Tran is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center, a former executive managing director at the Institute of International Finance and former deputy director at the International Monetary Fund.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post The US debt ceiling stalemate threatens money market funds—and financial stability appeared first on Atlantic Council.

By legal mandate, the Bank of Japan is primarily tasked with achieving price stability—avoiding inflation and deflation. However, as with many other central banks, it has two additional unwritten mandates. The first is “financial stability”: a mix of regulatory authority and emergency powers that give it the capacity to intervene in markets in the event of a systemic shock. The second is what might be called a “fiscal separation mandate”: a commitment to avoid conducting monetary policy in ways that substitute for or badly distort fiscal policy.

These three mandates have become dangerously intertwined such that making progress on one may require ceding ground on the others. And while the specifics of the Japanese case are inevitably unique, it’s only a matter of time before the difficult choices facing the BOJ show up in Washington, London, Brussels, Frankfurt, and beyond.

The Bank of Japan has struggled with price stability since 1989

Prior to the COVID-19 pandemic, the BOJ was in a long-running struggle against deflation, which prompted it to pioneer an extraordinary combination of exceptionally low interest rates and quantitative easing (QE).

Japan’s problems with low inflation began with the real estate and stock market bubble of the late 1980s, which ended with a financial crash that put the economy into a tailspin. That crash shocked companies and households into saving as much of their income as possible. Events were so severe that the “precautionary savings” mindset has never really abated, resulting in persistently low domestic demand, and downward pressure on prices.

However, in the post-bubble years two other global factors kept prices down, in Japan and across the developed world. Technology and global trade fundamentally changed the cost and location of producing goods and services. A typical product sold in the year 2020 was produced using far less labor than the equivalent product in 1990 and was more likely to be produced in an emerging market. Less demand for labor meant that household incomes in developed markets struggled to rise even as GDP went up substantially. Less labor pricing power and lower household incomes meant less upward pressure on overall prices. Put simply, technological advances together with increasing amounts of global trade were deflationary.

And Japan was early to face an additional challenge to price stability: a rapidly aging population. Japan’s prime working age population started to decline in the early 1990s. There is no expert consensus regarding the relationship between population growth and inflation, but in Japan’s case there’s a plausible argument that a declining population added to deflationary pressure. In a rapidly aging (and declining) population, the demand for goods and services may decrease more quickly than the supply.

Fast forward to 2023, and inflation has replaced deflation as the prevailing issue in Japan. Inflation is well above the BOJ’s 2% target, but policymakers still need to factor in the trends that kept inflation too low for decades: very high savings rates, global trade and technology, and an aging population. Two of the three are applicable well beyond Japan, and as the BOJ’s experience shows, they’re challenging to deal with—even before factoring in the central bank’s two other mandates.

Financial instability after years of low interest rates

Globally, instances of financial instability have become more frequent as central banks have raised interest rates to combat inflation in the US, Europe, and elsewhere. Further instability isn’t a certainty, but the events of SVB, First Republic, and others suggest it’s a good bet. Against that backdrop, Japan may be the poster child for an unpleasant paradox: the low interest rates and quantitative easing which rendered the Japanese financial system remarkably stable for almost 20 years may have sown the seeds of extraordinary financial instability to come.

Why a poster child? Because the BOJ started its “exceptional” policy interventions as early as 2001, which implies that the banks, borrowers, and securities markets have internalized historically abnormal BOJ policy settings as “normal.” The result has been stability but not normality. Trading volumes in government bonds (JGBs) have become anemic to the point where the benchmark 10-year bonds don’t trade at all on some days. And over this period, Japanese markets have been operationally hollowed out. The largest of the global brokers have reduced trader headcount and moved trading staff offshore due to minimal activity. There is little or no “living memory” among JGB market participants of how to operate amid volatility. And operational infrastructure may not be up to the task either: There’s reason to doubt that Tokyo market makers invested in state-of-the-art trading and risk management systems.

Finally, the “real economy” is vulnerable to higher rates and increased volatility—especially real estate, “mom-and-pop” businesses, and “zombie firms” with high debt.

The third imperative: fiscal separation

The third mandate—set by law in some countries and by tradition in most—is that central banks are committed to minimizing interference with fiscal operations. Rule One of fiscal separation is don’t lend to your government. The theory is that governments which borrow money that is “funded with a central bank’s fountain pen” lose all fiscal discipline, and that people stop believing that their government will return to anything like properly balanced budgets. They also stop believing that the central bank cares about price stability.

Alas, Rule Two is that there is always some linkage between monetary and fiscal policy, irrespective of commitments to “non-interference.” Why? Because governments which fund themselves in their home currencies do so at interest rates which are immediately and continuously impacted by central bank policy rates, and expectations about changes in those rates. When central bank rates go up, governments pay more to refinance maturing bonds and to finance any new deficits.

Japan, again, may provide the world with a test case that will either mitigate concerns, or magnify them. Japanese government debt as a percentage of GDP is the highest in the G7, according to the IMF, followed by Italy and the US. If the BOJ makes a material change to its interest rate policy, the flow-through to the fiscal accounts will be substantial.

Japan on the horns of a trilemma

The BOJ is in a difficult spot: a trilemma where strictly adhering to any one of its mandates may require sacrificing the other two. If it raises rates aggressively to fight inflation, financial stability will be threatened, and the fiscal consequences may be large enough to provoke political counter-reactions. By contrast, a focus on maximizing financial stability implies keeping rates too low for too long, and may result in ongoing, elevated inflation. Lastly, a compulsive focus on “non-interference” in fiscal affairs—for example, by staying out of the market for government bonds—could spark financial instability.

So now what?

Schadenfreude is not the appropriate response. Japan’s challenges are or will be common to much of the G7, if not the entire West. The West should be working constructively with Japan as it strives to balance its three mandates. Its success will be ours too, and we all need to learn what we can from the steps the BOJ takes and the consequences that follow. Our own “trilemmas” are not far behind.

Mark Siegel is a contributor to the GeoEconomics Center and Managing Partner at Chancellors Point Partners LLC. He previously worked in banking and investment management.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post <strong>Japan’s monetary trilemma is a warning to the world</strong> appeared first on Atlantic Council.

Domestic ambitions 

Even with its persistent low adoption rates, the e-CNY is by far the largest CBDC pilot in the world by both the amount of currency in circulation—13.61 billion RMB—and the number of users—260 million wallets. As the pilot regions have expanded to 25 cities, so have the real-world use-cases tested through the pilots. From the start, the PBOC’s objective within its borders has been to not just to compete in China’s domestic payments landscape, which is dominated by two “private” players—AliPay and TencentPay/WePay—but to expand the universe of economic activities that are included the state-enabled payments network. So far, common use-cases being tested include public transportation, public health checkpoints including COVID test centers, integrated identification cards to receive and pay utilities such as retirement benefits and school tuition payments, as well as tax payments and refunds. The pilots have also begun testing technical and programmability functions like smart contracts for B2B and B2C functions, e-commerce and credit provision. Some of these projects are described in the table below..

These domestic test cases are likely to expand this year and cover a broader range of activities and regions. Already, the PBOC is looking to reach the margins of society: e-CNY is being tested amongst elderly populations and in broader rural connectivity schemes initiated to improve digitization. It is also aiming to reach AliPay and TencentPay/WePay customers through integrating their wallet and e-commerce functions for e-CNY distribution. Over the last few years, the PBOC, like the broader Chinese state apparatus, has displayed a tendency toward centralizing regulatory authority when it comes to the two sectors at the intersection of CBDCs —finance and technology. The universe of expanded economic networks enabled by the e-CNY has rightly created concerns regarding the centralization of authority by the PBOC, and the resulting impacts on freedom of choice and from state surveillance for its users. The expanded network of use cases across applications that would collect data on personal identification, health information, and consumption habits and behavior should also raise concerns around the vulnerability of such data to cyber threats domestically and abroad. 

Recent developments on regulation

Interestingly, on the regulatory side, at the National People’s Congress in early March, there were a few changes announced to China’s financial regulators. The PBOC has lost its authority over financial holding companies and financial consumer protection regulation to a new regulator, the State Administration of Financial Supervision, which will also oversee banking and insurance regulation. The PBOC is also opening up 31 new provincial-level branches signaling deeper coordination between the PBOC and provincial level authorities. This reshuffle in authority signals further centralization of power under the party apparatus. Unlike other central banks, the PBOC is not fully independent, and requires the State Council to sign off on decisions relating to money supply and interest rates, and the State Council has been tracking PBOC’s research into e-CNY since approving the initial plan in 2016. 

From a monetary policy perspective, the e-CNY infrastructure could be a handy tool in the hands of the PBOC, with which it can increase or decrease money supply. As China devises a strategy to stimulate consumer spending this year, there is an opportunity to do so by using and expanding the e-CNY network. China has already increased bank’s short term liquidity by $118 billion and long term liquidity by $72 billion through reducing reserve ratio requirements this year.   

PBOC’s ambition for an all-encompassing domestic network of e-CNY infrastructure raises questions about the state’s ability and reach in controlling citizens’ activities. The pilots test real-world scenarios for CBDC use cases, and while adoption has been low, the broad range of applications suggest that testing, not adoption, is the priority for now.

e-CNY around the world

Use of the word “e-CNY” commonly refers to this domestic, retail payments infrastructure. However, much of the discussion in Washington references the cross-border, wholesale capabilities that the PBOC has been testing publicly for a while now. The PBOC participates in a joint experiment with the Hong Kong Monetary Authority, the Bank of Thailand, the Central Bank of the UAE and the Bank for International Settlements named Project mBridge, the purpose of which is to create a common infrastructure across borders to facilitate real-time and cheap transaction settlement. Last October, the project successfully conducted 164 transactions in collaboration with 20 banks across the 4 countries, settling a total of $22 million. Instead of relying on correspondent banking networks, banks were able to link with their foreign counterparts directly to conduct payments, FX settlements, redemptions and issuance across e-HKD, e-AED, e-THB and e-CNY. Interestingly, almost half of all transactions were in e-CNY, which amounted to approximately $1,705,453 issued, $3,410,906 used in payments and FX settlements and $6,811,812 redeemed. Both issuance and redemption transactions were highest in e-CNY, and as stated by the BIS, it was likely because of the automatic integration of the retail e-CNY system and the higher share of RMB in regional trade settlements. 

Analysts have characterized wholesale cross-border arrangements like the mBridge as an effort towards de-dollarization and internationalization of the RMB. The e-CNY, much like its physical counterpart, faces the same liquidity constraints due to capital controls on off-shore transactions and holdings. This was reflected in the mBridge experiment, as one of the main feedback from participants was the need for greater liquidity from FX market makers and other liquidity providers to improve the FX transaction capabilities of the platform. Additionally, even if e-CNY were to become freely traded in the future, it could lead to significant appreciation of RMB and balance of payments issues for the PBOC. This is likely not a desirable outcome for the PBOC, which is why currency arrangements like the mBridge can only have a limited impact on the role of the dollar.

If winning the currency competition is an unlikely short-term objective of the PBOC, what has raised national security concerns regarding the e-CNY? China has long used the rhetoric of international cooperation and “do no harm” principles in its cross-border CBDC engagements. However, these cross-border experiments require months of preparation and coordination between central and commercial banks to ensure that regulatory and jurisdictional requirements are aligned. They highlight the need for legal pathways and standards for data sharing, privacy, and risk frameworks between heretofore unsynchronized jurisdictions. Similarly, experiments rely on technological prototypes that interact with existing domestic e-CNY framework, creating de-facto technical standards for cross-border transactions which are likely to be replicated by other jurisdictions. What can potentially emerge is a set of technical and regulatory standards built in the image of the e-CNY, and with that comes the baggage of surveillance and unauthorized access by the Chinese state. MBridge’s platform, for instance, can be utilized for domestic CBDC infrastructure if required by any jurisdiction. 

Already, Chinese company Red Date Technology—which, along with China Mobile, UnionPay, State Information Center and others—is behind the creation of Blockchain Service Network (BSN) (a blockchain infrastructure service that connects different payment networks) has launched a similar product under the name of Universal Digital Payments Network. At an event at the World Economic Forum in January 2023, it targeted emerging markets experimenting with CBDCs and stablecoins, since the project wants to build an interconnected global architecture in the vein of BSN’s ambitions.

Technological and regulatory replication by country blocs, enabled by Chinese state and private actors, could create a parallel system of financial networks outside of the dollar, especially where there is a high volume of transactions. The United States relies on the dollar’s dominance to establish global anti-money laundering standards and achieve effective and broad implementation of financial sanctions. The emergence of alternate currency-blocs—enabled by e-CNY-like technology—has the potential to chip away at the primacy of the dollar in global finance and trade, as the dollar will not be the only available option. 

Therefore, even though it is unlikely that the development of e-CNY would lead to a broader share of the RMB as a payment or reserve currency, replication of the e-CNY’s technical and regulatory model could further payments infrastructure that is not only inherently unworkable with the dollar, but exacerbates the privacy and surveillance concerns of the retail e-CNY by exporting the problem to the world. China’s domestic motivations of greater control and surveillance, therefore, are intertwined with its global ambitions, and the consequences will be dire in the absence of a competing, privacy preserving, dollar-enabling, payments infrastructure.

Ananya Kumar is the associate director for digital currencies with the GeoEconomics Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

Check out our CBDC Tracker

Central Bank Digital Currency Tracker

Our flagship Central Bank Digital Currency (CBDC) Tracker takes you inside the rapid evolution of money all over the world. The interactive database now features 130 countries— triple the number of countries we first identified as being active in CBDC development in 2020.

The post <strong>Practice makes perfect: What China wants from its digital currency in 2023</strong> appeared first on Atlantic Council.

The post Tran cited in South China Morning Post on the risks of banking crises in the digital age appeared first on Atlantic Council.

The post CBDC tracker was cited in the Washington Post on how CBDCs have become politicized in the US appeared first on Atlantic Council.

The post Lipsky quoted in the Washington Post on how CBDCs have become politicized in the US appeared first on Atlantic Council.

Central bankers, finance ministers, executives, and civil-society leaders are meeting at the International Monetary Fund (IMF) and World Bank Spring Meetings this week with an ambitious economic-reform and fiscal agenda. The talks come six months after IMF Managing Director Kristalina Georgieva told the world’s economic leaders to “buckle up and keep going” in the face of multiple financial crises stemming from the pandemic, Russia’s invasion of Ukraine, global debt distress, high inflation, and more.

Amid all the uncertainty, a parade of central bank governors and finance ministers are visiting the Atlantic Council on the sidelines of the meetings and getting together with our experts to decode what is—and is not—happening behind the meeting’s closed doors. Below are our experts’ takeaways from our convenings, which feature leaders such as World Bank Group President David Malpass, and insights as the meetings unfold.

The latest from Washington

• Three new ways to support Ukraine, from Poland’s finance minister
• Sovereign debt restructuring: The kitchen lights are on, but where’s the beef? 
• The UAE’s trade minister on the new multilateralism
• How Ukraine’s digital innovations will shape reconstruction
• Economic policymakers shouldn’t fall into the trap of complacency
• The IMF missed an opportunity to take on the US debt ceiling debate
• What the World Economic Outlook didn’t say
• Who’s first and what’s second is this week’s central debate
• Central banks shouldn’t use IMF projections as an excuse to get too loose again
• Inside the World Bank’s digital governance agenda
• Spain’s economy minister aims to fight ‘fragmentation’
• ‘Sustainability, resiliency, and inclusion’ must top the reform agenda, says Cameroon’s minister of economy
• Senegal’s economy minister: ‘the US private sector is missing’
• David Malpass: Today’s economic double whammy may slam development into reverse

Three new ways to support Ukraine, from Poland’s finance minister

As Russia’s war on Ukraine puts major stress on the Polish economy, Poland’s Minister of Finance Magdalena Rzeczkowska visited the Atlantic Council on Friday to outline three ways how Western partners and multilateral institutions can support Poland’s goal of increasing military and financial assistance to Ukraine:

1. The European Union (EU) should provide funds to Poland for covering Ukraine-related expenses. Rzeczkowska drew attention to the fact that Poland’s total Ukraine-related spending, including military equipment and refugee accommodation, amounts to 2 percent of Poland’s gross domestic product. But Poland has not received funding from the EU to cover those expenses. Poland plans to increase spending both on Ukraine’s military equipment and its own defense. “It’s something that needs to be done because Ukraine is fighting for our future and freedom”, she said.
2. Multilateral organizations should allocate more funding for Ukraine. Rzeczkowska said that Poland is “very engaged with the IMF and the World Bank” and praised the institutions for the “proper answer” to the war, a program that has helped maintain Ukraine’s macro financial stability. Poland pushed the IMF to allocate its funding package for Ukraine, which will close Kyiv’s immediate budgetary needs and “give financial stability to Ukraine for four years.” Moreover, the European Bank for Reconstruction and Development has provided humanitarian aid to Ukrainian refugees in Poland. Rzeczkowska said that “Poland also wants to contribute to the fund which was created for Ukraine” by the European Investment Bank.
3. The Three Seas Initiative portfolio should include Ukraine’s reconstruction. Rzeczkowska believes that the Three Seas Initiative—a forum supported by the Atlantic Council—“is an important instrument for leveraging Central and Eastern European countries and building the North-South axis of infrastructure.” She argued that apart from its regular infrastructure-building and digitization agenda, the Three Seas portfolio should also include Ukraine’s reconstruction. While the Initiative struggles with the financing of projects and often requires compromises from member states, Rzeczkowska said it can be a strong and resilient instrument for Ukraine’s reconstruction and future growth of Europe.

—Maia Nikoladze is an assistant director with the Economic Statecraft Initiative in the Atlantic Council’s GeoEconomics Center.

Sovereign debt restructuring: The kitchen lights are on, but where’s the beef? 

As the Spring Meetings of the IMF and World Bank are winding down, more details are beginning to emerge from the closed-door meetings that were held on the touchy question of sovereign debt restructuring. The atmosphere around the new Global Sovereign Debt Roundtable appears to have been friendly and constructive, no doubt helped by the fact that Chinese officials were able to participate again in person. After all, despite extensive Zoom contacts over the past months, face-to-face meetings remain indispensable for finding a path through controversial, and possibly expensive, policy disagreements. 

The upshot is that the roundtable came to an agreement around several technical steps that could eventually facilitate the operation of the Group of Twenty (G20) Common Framework, but expectations for any concrete decisions or debt deals were (again) disappointed. Nevertheless, the areas of future work are concrete enough to suggest that progress on specific country cases may not be too far off. They include steps toward improving transparency around restructuring needs (where the IMF and World Bank would provide earlier insights into their debt sustainability assessments), a clarification of the role of multilateral development banks (MDBs), and further work on defining what constitutes comparable treatment of different credit classes. 

While China has not yet abandoned its demand that the World Bank and other MDBs share in any haircuts to official and private creditors, the latest signal from Beijing opens room for compromise, depending on the amounts of fresh concessional financing (and grants) that may be provided by multilateral lenders. One should of course not underestimate the capacity of international finance officials to make process look like progress, and it will be primarily up to China to demonstrate its willingness to help some of its poorest creditor countries back on its feet. 

China may still be hesitant to move fast, given that the long-overdue restructuring of Zambia’s debt could provide a hard-to-reverse model for the Common Framework. But there are now clear signs that the chefs are back in the kitchen, and one might hope that, with a few more ingredients, a palatable compromise may yet emerge.

—Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former IMF chief of staff.

The UAE’s trade minister on the new multilateralism

Economic fragmentation may be the hot topic at this year’s World Bank-IMF Spring Meetings, but that does not mean that all countries have lost faith in multilateralism. Just ask Thani Al Zeyoudi, the United Arab Emirates’ (UAE) trade minister. “While others talk about de-globalization,” he said at the Atlantic Council on Thursday, “we’re focused on economic expansion.” 

For Al Zeyoudi, that means establishing a wide network of trade partnerships from Israel to Indonesia, while liberalizing trade and foreign ownership regulations at home. The UAE’s aspirations to become a “global market” are vital to its economic health: With a post-hydrocarbon future on the horizon, the country is banking on finance, transport, and logistics as the foundation for future growth. But as we have heard throughout this week, the UAE is only one of a growing number of countries unconvinced by rising protectionism.

Countries in the Global South and their major hubs, like the UAE, have been some of the most vocal supporters of multilateralism. But this does not mean that these new champions are content with the trading order as it is. Al Zeyoudi argued that “there is a consensus that we need urgent reform for the multilateral trading system,” and his country has sought modernized trade mechanisms and new free trade agreements even as many of its partners pursue stricter trade controls. At this week’s meetings, we may see whether more countries heed his call.

—Phillip Meng is a young global professional at the Atlantic Council’s GeoEconomics Center.

How Ukraine’s digital innovations will shape reconstruction

Ukraine has emerged as an example of resilience against all odds, and on Thursday morning, Deputy Minister of Digital Transformation Alex Bornyakov discussed the digital infrastructure that will enable better outcomes for Ukrainians a year into the war. He was joined at the Atlantic Council by Mark Simakovsky, deputy assistant administrator at the US Agency for International Development’s bureau for Europe and Eurasia; Denelle Dixon, the CEO of Stellar Development Foundation; and Anatoly Motkin, president and founder of StrategEast. 

The panelists discussed the Diia app, which has become a hub for services such as education and skill improvement, health care, digital identification, and other government services. “We have shown through example how the interaction between the government and the citizen can be done in the twenty-first century, ” Bornyakov said.

The panelists emphasized the resilience of technology during the war, the role of the private sector (both domestic and international) in reconstruction and development, and the challenges of corruption and accountability. “The private sector will have to be induced to go to Ukraine,” Simakovsky said. “Ukrainians will have to accelerate the reform and have to ensure that the decentralization that happened before the war is going to continue.”

Both Dixon and Bornyakov spoke about the role of women in building resilient infrastructure for the future and how technology can bridge the existing gap. The panelists also discussed innovation in payments architecture, such as central bank digital currencies, as well as the role of cryptocurrency in Ukraine’s economy. 

—Ananya Kumar is the associate director of digital currencies at the Atlantic Council’s GeoEconomics Center.

Economic policymakers shouldn’t fall into the trap of complacency

During the IMF/World Bank Spring Meetings, some officials—in particular US Treasury Secretary Janet Yellen—have downplayed the risks and negative impacts of last month’s bank failures, repeating the mantra that major banking systems are healthy. While banking turmoil has indeed subsided, it is important to guard against being complacent about the threat of “further bouts of financial instability… [due to] stresses triggered by the tighter stance of monetary policy”—as the IMF pointed out in its Global Financial Stability Report.

Tellingly, the report estimated that almost 9 percent of US banks with assets between ten billion and three hundred billion dollars would become undercapitalized (with their Common Equity Tier 1 capital ratios falling below the regulatory minimum of 7 percent) if forced to fully account for the unrealized losses on their holdings of US Treasuries and agency mortgage-backed securities (due to rising interest rates). Going forward, if the coming recession turns out to be more severe than expected, credit risk losses on bank lending, especially in the commercial real estate sector, would be significant.

On top of banks’ interest rate and credit losses, there have been tremendous deposit outflows from banks to money market funds. JPMorgan Chase has estimated that “vulnerable banks” have lost about one trillion dollars of deposits in the past year. Specifically, the top three US banks (JPMorgan, Wells Fargo, and Bank of America) have revealed a huge $521 billion deposit drop over the past year. The combination of losses on assets and deposits proved fatal to the failed banks last month and could yet strike vulnerable banks again.

More broadly, banking stresses have significantly tightened financing conditions, leading to a record contraction in US bank lending of nearly $105 billion in the two weeks ending on March 29. If this continues, declines in bank lending will tip the US economy into a recession sooner than expected, causing credit losses in a negative feedback loop. Policymakers need to be aware of this trend and try their best to mitigate it.

—Hung Tran is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center, a former executive managing director at the Institute of International Finance, and former deputy director at the IMF.

The IMF missed an opportunity to take on the US debt ceiling debate

Rarely have the IMF’s World Economic Outlook and associated documents been written under as much uncertainty as now, with two significant bank failures happening in the middle of the drafting process. Yet, the IMF has managed to get together a set of sensible reports, with the uncertainty reflected not so much in this year’s growth projections than in the fairly sober medium-term outlook and the extensive discussion of risks.

The reports highlight the tight constraints on growth and policy faced by policymakers around the globe, and the IMF is right that, barring major financial shocks, monetary policy will need to focus on bringing down inflation expectations and fiscal policy will need to be supportive in this regard.

Given that they are vetted by the IMF membership in what is usually a very long board discussion, it is normal that the reports end up a little on the bland side, with carefully worded country-specific references, if any. Still, it is surprising that there is no discussion of the debt ceiling talks that currently appear stalled in the US Congress. The risk of a breach of the United States’ fiscal obligations, even if temporary, would have major repercussions both for the United States and the world economy—and possibly for the broader global financial system. 

The IMF missed a major opportunity this time around to remind the United States of the severe consequences for itself—and the rest of the world—of not living up to its responsibilities as the issuer of the world’s major reserve currency. One would hope that IMF delegates still use these Spring Meetings to drive home this point to their US counterparts. 

—Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former IMF chief of staff.

What the World Economic Outlook didn’t say

On Wednesday, Atlantic Council senior fellows gathered to discuss the World Economic Outlook (WEO) report that was released by the IMF this week. The WEO is published twice a year and presents the IMF’s analysis of global economic developments over the near and medium term. This year, the report comes in the midst of tightening financial conditions in most regions and the aftermath of a banking crisis. The IMF forecasted that global growth will slow from 6 percent in 2021 to 2.7 percent in 2023.

The former IMF officials led a discussion to decode the WEO and address which elements they felt were missing. While participants cannot be quoted directly as the conversation was conducted under Chatham House rules, the experts generally agreed that the report was missing important discussions in several areas: the US debt ceiling, artificial intelligence, structural reforms to address aging populations and declining productivity, and the normal analysis of specific countries or regions. The group talked about the report’s increased attention toward economic fragmentation despite the political sensitivity of this issue. In addition, they discussed the potential for stagnation versus stagflation and the complexity of debt relief with China and private creditors. The experts also gave a defense of the WEO and why it matters in an economically divided world.

—Jessie Yin is a young global professional at the Atlantic Council’s GeoEconomics Center.

See more expert reactions from our WEO roundtable:

Who’s first and what’s second is this week’s central debate

Whether the topic at hand is COVID-19 debt fallout, the Ukraine conflict, climate finance, food security, or supporting small states, a common theme in deliberations thus far during the IMF-Word Bank Spring Meetings has been how to balance clear but competing needs in the short term versus the medium and long term. The threat of a “lost decade” of global growth adds urgency to figuring a path forward quickly.

There does seem to be consensus that multilateral financial institutions—and indeed, the entire global financial and development system—need to walk and chew gum at the same time. That is, they need to respond to urgent and basic needs, such as widespread food insecurity, while simultaneously investing in what is needed for economic recovery and inclusive growth; for example, investing in infrastructure and health systems. Some argue education is a medium-to-long term economic development need, but the 70 percent of the world’s ten-year-olds in low- and medium-income countries who cannot understand simple text and the hundreds of millions of unemployed youth might disagree. Climate change is seen as both an immediate and an existential threat—and, increasingly, a market opportunity. 

The debate this week in Washington, then, is less about which crises or challenges to address, and more about who should do what, when, and how. There are arguments for the IMF returning to a focus on liquidity and macro-fiscal and short-term stabilization, while the World Bank should focus on medium- to longer-term recovery and economic growth and development. It is too soon, however, to know if the arguments for this way forward will win out. Importantly, there is agreement that to tackle these problems both sides of 19th Street, along which the institutions sit (with the International Finance Corporation just up the road), need to incentivize and mobilize more private-sector capital and engagement, and better coordinate with other multilateral and bilateral agencies. Watch this space.

—Nicole Goldin is a nonresident senior fellow at the GeoEconomics Center and global head of inclusive economic growth at Abt Associates, a consulting and research firm.

Central banks shouldn’t use IMF projections as an excuse to get too loose again

The IMF’s World Economic Outlook expects global growth to remain around 3 percent in the next few years—lower than the 3.9 percent annual average from 2000-2009 and 3.7 percent from 2010-2019. This low growth estimate is based on expectations of a return to secular stagnation driven by long-term trends such as aging populations and slowing productivity growth, pushing the natural real interest rate (known as r*) to ultra-low levels comfortably below 1 percent.

This may or may not be the case. But the World Economic Outlook does not clearly mention the chance that secular stagflation is equally likely as secular stagnation to happen—especially since geopolitically driven fragmentation will likely reduce output and increase costs and prices. This comes on top of the fact that deglobalization has reversed the disinflationary benefits of the globalization period when hundreds of millions of low-wage workers in China and other emerging markets joined the global economy.

Consequently, the possibility of ultra-low r* should be viewed cautiously, as both inflation and nominal interest rates may be higher than in previous decades. Central banks should not use that as an excuse to implement extraordinary loose monetary policies like they did in the decade or so after the Global Financial Crisis—policies that boosted financial asset prices, causing recurring financial instability and now persistently high inflation requiring central banks to sharply raise interest rates. This is a hard-earned lesson that should not be quickly forgotten.

—Hung Tran is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center, a former executive managing director at the Institute of International Finance, and former deputy director at the IMF.

Inside the World Bank’s digital governance agenda

As global conversations accelerate around digital-first governance, the emerging agenda must be based on “inclusion, competition, and trust,” said Priya Vora, managing director at Digital Impact Alliance (DIAL). 

Vora spoke Tuesday at an Atlantic Council event along with Arturo Herrera Gutiérrez, global director for governance at the World Bank, and Tim Murphy, chief administrative officer at MasterCard, to discuss how the World Bank should address digitalization. 

Participants in the roundtable, conducted in partnership with the Mastercard Policy Center for the Digital Economy, had one clear message: “The public sector cannot sit back anymore.” The real role of the US government, as Vora underscored, is to create the tools for an equitable and safe digital economy, then lead by setting global standards. 

This process starts with people-centric innovation coupled with comprehensive regulation. Gutiérrez stressed that countries cannot simply provide a technical solution, rather they need to create an “engagement strategy” to best inform consumers about the benefits and risks of that technology. 

The United States, as Murphy noted, is falling behind. As countries trend towards digitalization, Murphy warned about the threat of fragmentation, in which different countries have their own siloed digital priorities and issues of privacy, data protection, and consumer transparency are often ignored because of a focus on geopolitical competition. Therefore, the panelists agreed, global leadership and cooperation are crucial, especially to understand both the negative and positive opportunities of technology development.

The World Bank’s governance agenda will need to adapt to reflect the dynamics of the digital economy, including issues of privacy, cybersecurity, consumer protection, and sustainability. The next wave of innovation should be about “giving more tools of transparency and control to people,” said Vora. 

—Alisha Chhangani is a program assistant at the Atlantic Council’s GeoEconomics Center.

Spain’s economy minister aims to fight ‘fragmentation’

Nadia Calviño, Spain’s vice president and minister of economic affairs and digital transformation, declared on Tuesday that economic fragmentation would be a “lose-lose” situation for major economies. At an event at the Atlantic Council, Calviño noted that a “massive tectonic plates shift” is taking place within the post-World War II geopolitical order that has benefited the global economy. Economic ties are increasingly linked to geopolitical allies, and new research from the IMF shows that if geoeconomic fragmentation were to deepen, the global economy would contract by about 2 percent. This contraction would be far worse for developing economies.

Calviño believes that the World Bank and IMF will play key roles in avoiding such fragmentation and ensuring prosperity for all. Difficult discussions around debt relief, climate change, and economic slowdowns should not weaken the role of the institutions as financial stabilizers and promoters of development, she said. If the Bretton Woods Institutions didn’t already exist, “we’d have to invent them now.”

As the chair of the IMF’s International Monetary and Financial Committee, Calviño has three goals for the meetings this week. First, she aims to generate a consensus on reinforcing the global safety net and supporting the most vulnerable economies. Second, she plans to deliver a message of confidence that will also bring confidence to global economic markets. And third, which would be a bonus, she hopes to build a framework to coordinate economic policies that would encourage financial stability and prevent geoeconomic fragmentation.

This will not be an easy task. But Calviño is “neither optimistic nor pessimistic but determined” to make progress on these issues in a period of global economic uncertainty and volatility.

—Mrugank Bhusari is an assistant director at the Atlantic Council’s GeoEconomics Center.

‘Sustainability, resiliency, and inclusion’ must top the reform agenda, says Cameroon’s minister of economy

At the Atlantic Council, Cameroon’s minister of economy laid out the country’s economic trajectory in conversation with Julian Pecquet, the Washington/UN correspondent for Jeune Afrique and the Africa Report. Despite modest growth in the face of significant global pressures, it is “not enough for [Cameroon] to get to [its] goals of becoming an emerging country by 2035,” Ousmane Mey said.

A “paradigm shift” is underway in Cameroon’s economic planning, the minister of economy explained, as the country continues to learn from the disruptions of the COVID-19 pandemic and the pressures of the war in Ukraine. He said that in particular, the Cameroonian government wants to “take advantage of the situation to reengineer [its] production capacity to be able to produce more locally, cover the national demand, and export more in this environment.” At a broader level, the African Union is also working to “integrate and trade more between the countries” to promote resiliency and insulation from global crises at a continental level, Ousame Mey explained.

At the same time, he said, the stressors climate change is imposing on Africa, even though the continent contributes the least to global pollution, are closely tied to Cameroon’s economic goals. The minister noted that “sustainability, resiliency, and inclusion” must be at the forefront of the agenda for international monetary institutions. These issues are informing Cameroon’s position going into the Spring Meetings, explained the minister, who expects the talks to focus on “the future of the [Bretton Woods] institutions,” “reforms,” and “global challenges.” Particularly on the topic of reforms, he praised the “debt service suspension initiatives” that were introduced in 2020 under the Group of Twenty common framework to alleviate Cameroon’s burden in a time of crisis. “This is certainly something we should include in the reform of the financial architecture in the future,” he said.

—Alexandra Gorman is a young global professional at the Atlantic Council’s Africa Center.

Senegal’s economy minister: ‘the US private sector is missing’

Senegal’s newly appointed Minister for Economy, Planning, and Cooperation Oulimata Sarr has one clear message for international partners going into the IMF/World Bank Spring Meetings: “Senegal is open for business.”

In a conversation at the Atlantic Council with Julian Pecquet, the Washington/UN correspondent for Jeune Afrique and the Africa Report, Sarr acknowledged that she wants “the private sector to a play a much bigger role” in the country’s economy, which has grown rapidly in the past few years. In particular, “the US private sector is missing” in Senegal, she acknowledged, because it tends to view “Africa as a whole as a risky investment place.”

A major factor that shapes these views is sovereign debt credit ratings, which have historically been administered by foreign-based entities that rely on faulty metrics, Sarr said. The rise of credit rating agencies on the continent (currently there are two) will more accurately reflect the reliability and investment potential of African economies, Sarr noted.

Ultimately, “development cannot wait,” she told US viewers, noting the urgency of the issue. “Fast-tracking” solutions is the country’s top priority in all economic considerations, from “the reform of the Bretton Woods Institutions” to the choice of partners between the US and China. The current Biden administration clearly sees “Africa as a very, very important player” and “as a land of opportunity,” but she believes that the “US can do much more.”

—Alexandra Gorman is a young global professional at the Atlantic Council’s Africa Center.

David Malpass: Today’s economic double whammy may slam development into reverse

As World Bank President David Malpass prepares to hand over the reins to his successor, he has one big worry about the global economy: a “reversal in development.” 

“That means poverty is higher… than five years ago, that education and literacy problems are worse than they were five years ago,” he said at an Atlantic Council Front Page event on Tuesday hosted by the GeoEconomics Center. That reversal is unfolding, he explained, because of the COVID-19 pandemic and Russia’s full-scale invasion of Ukraine, which together hit the global economy with a “double whammy.” 

But even if these crises come to an end, development won’t necessarily get right back on track, warned Malpass, who will be succeeded in the coming weeks by former Mastercard Chief Executive Officer Ajay Banga. Next week, the boards of governors of the World Bank and International Monetary Fund (IMF) will meet in Washington to discuss reshaping development for a new era as central banks around the world raise interest rates to fight inflation.  

“The dislocation is huge,” Malpass said, explaining that countries looking to continue their growth strategies from the past decade will now see higher interest rates reflected on their contracts. Thus, instead of looking to return to pre-COVID development economics, Malpass explained, countries should be looking at this moment as “an inflection point into some new [economic] growth model”—and adjusting their strategies accordingly. 

“We don’t want it to be a lost decade for growth,” Malpass said. Preventing one, he added, will require sorting out global debt restructuring and increasing the resources available to the World Bank. 

—Katherine Walla is an associate director of editorial at the Atlantic Council.

Read more

New Atlanticist

Apr 5, 2023

David Malpass on China’s role in the World Bank and how to prevent a ‘lost decade for growth’

By Katherine Walla

The president of the World Bank, speaking at the Atlantic Council as he prepares to hand over the reins to his successor, has one big worry about the global economy: a “reversal in development.” 

Digital Currencies Economy & Business

Dive deeper

IMF-World Bank Week at the Atlantic Council

APRIL 10–APRIL 14, 2023

Highlights from the Atlantic Council’s IMF-World Bank Spring Meetings. Watch the special events with finance ministers and central bank governors from around the world.

The post Highlights from the sidelines of the IMF and World Bank Spring Meetings appeared first on Atlantic Council.

The post Lipsky quoted in AFP Fact Check on how privacy laws would apply to a digital currency system appeared first on Atlantic Council.

Watch the full event

Online Event Tue, April 4, 2023 • 10:00 am ET

Special event with President of the World Bank Group David Malpass

AN #ACFRONTPAGE EVENT – Malpass shared his vision for how the World Bank Group can respond to global challenges and help foster inclusive growth around the world.

Economy & Business Fiscal and Structural Reform Inclusive Growth International Financial Institutions

As World Bank President David Malpass prepares to hand over the reins to his successor, he has one big worry about the global economy: a “reversal in development.” 

“That means poverty is higher… than five years ago, that education and literacy problems are worse than they were five years ago,” he said at an Atlantic Council Front Page event on Tuesday hosted by the GeoEconomics Center. That reversal is unfolding, he explained, because of the COVID-19 pandemic and Russia’s full-scale invasion of Ukraine, which together hit the global economy with a “double whammy.” 

But even if these crises come to an end, development won’t necessarily get right back on track, warned Malpass, who will be succeeded in the coming weeks by former Mastercard Chief Executive Officer Ajay Banga. Next week, the boards of governors of the World Bank and International Monetary Fund (IMF) will meet in Washington to discuss reshaping development for a new era as central banks around the world raise interest rates to fight inflation.  

“The dislocation is huge,” Malpass said, explaining that countries looking to continue their growth strategies from the past decade will now see higher interest rates reflected on their contracts. Thus, instead of looking to return to pre-COVID development economics, Malpass explained, countries should be looking at this moment as “an inflection point into some new [economic] growth model”—and adjusting their strategies accordingly. 

“We don’t want it to be a lost decade for growth,” Malpass said. Preventing one, he added, will require sorting out global debt restructuring and increasing the resources available to the World Bank. 

Below are more highlights from the event, moderated by Bloomberg Surveillance co-host Lisa Abramowicz, as Malpass dove into the World Bank’s role in the world, its relationship with its contributors, and global financial and monetary challenges. 

World Bank, global problems 

• Malpass pointed out how over the past few decades, as countries face increasing costs, the bank’s contributions from shareholders and donors have “been relatively flat.” Given that “there were no more donations from the advanced economies,” the World Bank instead leveraged its balance sheet to expand funding for programs such as its International Development Association, which works to combat extreme poverty. 
• The flat donations are, in part, due to countries allocating spending to their own international development programs, Malpass admitted, but he noted that all bilateral aid hasn’t grown very much.  
• There’s one big exception to this trend. “China has substantially increased its contribution to the World Bank,” he explained. In response to critiques about China’s lending practices, Malpass argued that the country is the “world’s second-biggest economy, so… there needs to be some component of China’s involvement and engagement.” 
• At the same time, Malpass explained, the World Bank is working with Beijing on improving its development practices and avoiding such practices as requiring nondisclosure clauses and asking countries for collateral. “Billions and billions of dollars… are flowing with insufficient transparency,” Malpass warned. “That’s a high priority as the world interacts with China in a global context.” 
• “What we want China to see is that it is strongly in its interest to see the world growing,” Malpass added. “That can be done through a difference in lending practices—also a faster restructuring of debt.” Why hasn’t that debt restructuring happened yet? Beijing is “looking for a way to have a constructive restructuring dialogue with the world,” Malpass explained. 
• In discussing which countries the World Bank prioritizes for its lending programs, Malpass said the question often involves whether to focus on long-term projects or fast disbursements of money. “There’s a lot of pressure on the World Bank to just lend the money to the country, even if they’re not doing well” on governance and corruption. “We still operate in those countries, but we tend to do it more with social safety nets” and “direct assistance to the people of the country” so that they can survive food shortages and economic hardship. 

Currency: Dollar and digital

• Despite today’s high inflation, the dollar is still strong, Malpass said, adding that he isn’t worried about preserving the dollar’s status as the world’s reserve currency. “You earn that by dependability and by how fast you can trade the currency,” he said. “The US still has dominance in that.”  
• In the meantime, China’s renminbi, which is one of a handful of currencies that make up the IMF’s Special Drawing Rights reserves, has the potential to grow as a reserve currency, Malpass argued. But “competition is good for a currency,” he said, adding that it will push the United States to “really have strong financials… so that the dollar can remain the world’s most important currency.” 
• Malpass briefly discussed the risks that cryptocurrencies pose: He noted that, for example, they grant a measure of anonymity, making it easier to lose track of terrorism financing. Central banks will have to “speed up their settlement process,” he said, to offer a digital currency option that competes with cryptocurrencies while avoiding those risks.  

Crises underway—and on the horizon

• Malpass said that the recent string of bank failures starting with Silicon Valley Bank has increased the risk of a recession. As small and regional banks are under increasing stress, he added that the financial system needs to maintain access to the kind of small loans and local community service these banks provide. 
• With members of the OPEC+ oil cartel, which includes the Persian Gulf countries and Russia, announcing a voluntary cut to oil production on Sunday, Malpass had a grim outlook for global growth. He explained that as oil prices go up, the costs of agricultural inputs and healthy food will rise as well, with devastating impacts on food systems and health. 
• The World Bank responded to Russia’s full-scale invasion of Ukraine by offering direct grants to Kyiv and setting up trust funds that the United States has used to send non-military support to Ukraine. The bank has also conducted damage assessments to help international partners understand the amount of money needed to rebuild the country—and it will continue working on reconstruction with the United States and the European Union, Malpass said. 

Katherine Walla is an associate director of editorial at the Atlantic Council.

Watch the full event

The post David Malpass on China’s role in the World Bank and how to prevent a ‘lost decade for growth’ appeared first on Atlantic Council.

He expressed the Chinese Communist Party’s (CCP) surprise and unease over how problems reverberating from the US financial sector hurt China and promised to re-examine the Chinese financial sector’s linkages to the US. He then announced the party’s new strategic priority to refocus Chinese finance on its domestic economy as a way to tackle the crisis and stave off future shocks from overseas.

At the time, the declaration went largely unnoticed. There were too many other problems to deal with. But nearly fifteen years later, as the global economy confronts another wave of bank failures, it’s clear China followed through on Wen’s promise. 

The effects of Silicon Valley Bank’s (SVB) and Credit Suisse’s collapse have reverberated across every major economy—except one. The KBW Nasdaq Bank Index, which tracks the performance of the world’s leading Globally Systemically Important Banks (G-SIBS) is down 17 percent from March 7 to its trough on March 24. China, however, remains an outlier. Why? 

Scars of the Great Recession

2008 was a turning point in China’s liberalization of its financial sector. The crisis exposed what Beijing perceived to be unacceptable cross-border risks between the United States and China. The collapse of Lehman Brothers shocked China’s leaders. Not because they were overly concerned about contagion—they had fiscal and monetary tools to deal with the immediate economic problems. But because they saw that the United States was willing to let its major financial institutions fail. This made connections to the US system overly risky.

The Great Recession also forced the CCP to reassess the model it would structure its financial system around. The crisis revealed a more volatile and risky face of Western banking. Leading government-affiliated scholars became increasingly skeptical of a market approach to finance, which they saw as driving financial instability in the United States and Europe. 

China’s immediate response to the crisis was to rely on its state-owned banks. In conjunction with a massive fiscal stimulus program, Beijing instructed these institutions to substantially increase lending. Total domestic credit grew by more than one-third in 2009. It was through these state-owned banks and enterprises that China’s real economy—unlike Western economies—escaped relatively unscathed by the financial crisis and maintained employment despite a collapse of global trade. 

As China recovered from the recession, the dominant perception among policy makers and influential scholars became that insufficiently regulated financial markets caused the crisis. State-ownership, on the other hand, was fundamental to ensuring China could weather and then quickly exit it. 

These lessons laid the foundation for policy changes that have insulated the Chinese banking system from the collapse of SVB and Credit Suisse. 

Banking with Chinese characteristics

While 2008 forced Chinese policy makers to recognize these risks, other priorities delayed any action. They still wanted to integrate some parts of their economy into the global financial system such as including the Yuan in the IMF’s Special Drawing Right (SDR) basket. It was only in the later part of the decade, following its 2015 stock market crash that Beijing began implementing this policy pivot.

In 2015 the pop of a market bubble saw the Shanghai Stock Exchange lose more than 48 percent of its overall value. After the incident, financial regulation was named a top political priority at the 2017 National Financial Work Conference, a twice-a-decade event which set the scene for the country’s financial sector for the next five years. 

In the ensuing months, Beijing appointed a new top bank regulator who began implementing a “windstorm” of new regulations. In order to de-risk the sector, policymakers tightened controls on cross-border transactions, capital movement, and overall exposure to other markets. The following year Beijing also drew banks closer to the state. Regulators pushed banks to establish Communist Party Committees with a wide oversight purview. Most were formed with the stipulation that they would be consulted before corporate strategy was agreed upon. As our China Pathfinder project, a collaboration with Rhodium Group, shows, this—in conjunction with other measures—has led to a financial system with intense state supervision.

These reforms, as well as the banking structure that predated them, has generated major differences between China and Western approaches to banking. China has a high level of state ownership and control of its banking sector, and a government that more actively intervenes in banking decisions. 

As Premier Jiaboa promised, the result is a banking sector that is exceptionally focused on China’s domestic economy and adverse to cross-border risk, especially from Western economies. In 2021 cross-border lending of Chinese banks represented less than 5 percent of their total balance sheet. In the United States, cross-border lending constitutes more than 22 percent of its banks’ balance sheets. What little cross-border lending China does engage in is focused on emerging and developing economies. This lending can often be understood as a policy choice serving strategic goals, such as the Belt and Road Initiative. 

These policy choices have led to a financial system with more immunity to the problems facing the United States and Europe. While the collapse of Credit Suisse and SVB reverberated across all major Western financial capitals, China, with the world’s largest banking sector, was largely unimpacted. 

But that protection comes with its own costs.

First, Chinese finance is continually plagued with inefficient capital allocation. This is prominently playing out in the semiconductor industry with reports that senior officials are increasingly angry at the lack of development progress despite the tens of billions of dollars they have funneled into the industry over the past decade. Second, China’s lack of international and advanced economy banking connections mean it plays an undersized role in global banking standard setting such as the Basel Committee. For a country that has promised more international leadership in recent years, its lack of a large international financial presence often precludes it a seat at the rulemaking table (time will tell if China’s ambitions toward Hong Kong change this dynamic). Finally, its banking system is unable to offer Chinese savers attractive investment products, leading to other economic imbalances—including an asset price bubble in the country’s property sector. 

Similar to China’s zero-COVID policy, financial isolation comes with tradeoffs. While it may create a system that is relatively unphased by crises abroad, it also can generate and amplify endogenous issues within China’s own economy. 

Josh Lipsky is the senior director of the Atlantic Council’s GeoEconomics Center and a former adviser at the International Monetary Fund.

Niels Graham is an Assistant Director with the Atlantic Council GeoEconomics Center focusing on the Chinese economy.

The authors would like to thank GeoEconomics Center YGP Phillip Meng for his excellent research support.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Chinese banking’s SVB resilience  appeared first on Atlantic Council.

After the sale of Credit Suisse, the most poignant example of investor concerns is the market pressure on Deutsche Bank (DB).  DB shares have lost more than a fifth of their value this month—despite improving its financial performance in recent years. Following significant restructuring efforts since 2019, DB has posted ten consecutive quarters of profit, including a net income of €5 billion ($5.4 billion) in 2022, a 159 percent increase from 2021. At the end of 2022, its Core Equity Tier 1 capital ratio was at 13.4 percent, Liquidity Coverage Ratio at 142 percent and Net Stable Funding Ratio at 119 percent—all meeting Basel III regulatory requirements. 

The satisfactory regulatory ratios for most banks in the US and Europe have enabled financial authorities to insist that their banking system is basically safe and sound. Investors, however, have taken a different view. Since the 2008 global financial crisis, the ratio of market share price to net book value (assets minus liabilities) of European and US banks have traded at half of their pre-2008 averages. Specifically, European banks have traded at around a P/B ratio of 0.6–meaning investors value banks’ net assets at much less than what their financial statements show, reflecting lack of confidence in the profitability of those banks. By comparison, the P/B ratio of US banks has been around 1.4.

In short, the turmoil in the banking sector of global equity markets reflects the lack of confidence that banks can cope with the current and expected difficult business environment. Most worrisome is a likely recession that would cause losses in banks’ loan and credit portfolios. 

Besides interest rate risks, which have materialized due to quickly rising interest rates, credit risk is the second shoe to drop. Some economists have looked for this event to assess the severity of what increasingly appears to be a systemic financial crisis. Financial regulators have identified several areas of vulnerability that can crystallize into losses: commercial real estate, construction loans, and leveraged loans packaged into Collateral Loan Obligations. Those financial products have been distributed widely beyond the banking sector— to pension funds, insurance companies, and investment funds.  Some investment funds are vulnerable to redemption runs by their investors, thus bearing similar risks as SVB and Signature Bank of asset losses combined with unstable funding.

Unfortunately, under current unsettled financial conditions, monetary policy and financial stability policy as articulated by authorities have failed to reassure market participants. At times, they even seem to have the opposite effect.

Major central banks, most notably the Federal Reserve System and the European Central Bank, have continued to tighten.  However, the Fed has done so by less than it planned to, and the tightening has been accompanied by changes in rhetoric. The words “ongoing increase” became “some additional firming” in the recent Federal Open Market Committee statement. The banks have also indicated that they are prepared to raise rates further if inflation remains stubbornly high. The message sent to financial markets implies that, as a last resort, central banks are prepared to accept a recession to bring inflation under control. Consequently, market participants must price this possible outcome, focusing on the weak link—being banks and, eventually, other non-banking financial institutions.

Central banks have also emphasized that they will closely monitor financial market instability and stand ready to supply liquidity as needed. However, in the case of the United States, tension is revealed in the changes in Treasury Secretary Janet Yellen’s recent remarks. On March 22, 2023, she said she had not considered blanket insurance to all deposits (as requested by a group of mid-sized banks) without congressional approval. The following day, Yellen said she was prepared to stabilize banks and ensure the safety of their deposits. Amid growing political opposition to what is perceived to be bailouts of large depositors of the two failed banks, there is uncertainty about whether and to what extent the US Department of the Treasury and regulators can protect all bank deposits without congressional approval. This is especially difficult to predict given political divisiveness in the United States.

More importantly, supplying liquidity, while useful, may not be sufficient to quell the current market turmoil. This is despite the simplistic belief that authorities have a set of policy tools to deal with financial crises, separate from interest rate policy. Specifically, the problems facing banks are not necessarily liquidity or solvency weaknesses, but due to investor loss of confidence. Many banks—like DB—have maintained adequate capital and liquidity positions, but still came under market pressure when their investors lost confidence in their ability to navigate the difficult period ahead. Unfortunately, the authorities have amplified this fear by raising the risk of a recession and its attendant credit losses.

At this juncture, it is important for central banks to recognize that combating inflation is important in the medium term, while averting a full-blown global financial crisis is an acute problem which should be prioritized now. Central banks should do everything they can, including becoming more flexible in their interest rate decisions to calm down equity markets, especially for banks. At the same time, they should communicate their commitment to bring inflation under control over time.

This is a tall order for central banks and authorities to rise to in today’s politically polarized circumstances. But the stakes are much higher for everyone. There is a greater risk of losses of output, employment, and wealth in a recession accompanied by a banking crisis.

Hung Tran is a nonresident senior fellow at the Atlantic Council; a former executive managing director at the Institute of International Finance and former deputy director at the International Monetary Fund.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Loss of investor confidence and the banking crisis  appeared first on Atlantic Council.

Russian oligarch assets should be used now to support Ukraine

The European Commission estimates that Russian President Vladimir Putin’s war has caused an estimated $650 billion (converted to dollars from the original source) of damage to the Ukrainian economy. There is broad international agreement that Russia should pay for the damage it has caused. However, the debate remains as to how and when Russia should pay. It is important to distinguish between immobilized Russian state assets and blocked Russian oligarch assets. Currently, the authority does not exist to seize state assets and transfer them to Ukraine. It would require new legislation or amendments to existing law. It could also erode non-Western countries’ perception of the United States as a safe place for parking their reserves. Meanwhile, the United States and European Union (EU) member states already have the legal authorities and mechanisms to seize and transfer sanctioned oligarch assets. 

What are the immediate steps? 

Seize the blocked fifty-eight billion dollars’ worth of sanctioned oligarch assets and expedite their transfer to Ukraine. The multilateral Russian Elites, Proxies, and Oligarch (REPO) Task Force, run by finance and justice ministries of Western ally states, recently reported that REPO member states have blocked fifty-eight billion dollars’ worth of sanctioned Russian oligarch assets. Fortunately, in the United States the legal process for seizing sanctioned assets is already in place: a judge in Manhattan federal court recently ordered the confiscation of $5.4 million from sanctioned Russian oligarch Konstantin Malofeyev. The forfeited funds will be transferred to the State Department to provide assistance to Ukraine. 

Additionally, last month, the US Department of Justice’s (DOJ) KleptoCapture Task Force filed a civil forfeiture complaint against six properties owned by sanctioned Russian oligarch Viktor Vekselberg, worth seventy-five million dollars. DOJ is aggressively moving forward with its civil and criminal forfeiture tools and new authorities to seize sanctioned Russian assets to make them available to Ukraine. The same steps should be repeated across REPO member states with asset seizure authorities for the rest of the fifty-eight billion dollars held in their jurisdictions on an expedited timeline. 

There is also likely more Russian oligarch money abroad that has not yet been identified and frozen. Western authorities should use existing mechanisms and processes to locate these assets, freeze them, seize them, and transfer them directly to Ukraine.

One potential challenge to this plan is that prosecutors will need to provide evidence of oligarch assets’ involvement in international money laundering and sanctions violations. This could limit the pool of forfeitable money. However, the successful transfer of millions of dollars from Malofeyev and Vekselberg to Ukraine will prove that this path is worth going down. 

Make Russia pay for reparations. Not seizing Russian state assets right now does not mean that Group of Seven (G7) allies will simply transfer them back to Russia once the war is over. The United Nations (UN) General Assembly has already adopted a resolution calling on Russia to pay reparations for its damage to Ukraine. State assets can remain immobilized until Russia agrees to pay and if Moscow fails to do so, sovereign assets can then be seized as collateral. 

Further, it is important to remember that allies have rightfully provided significant amounts of funding to support Ukraine in its efforts to fight back against Russian aggression. The top ten contributors have pledged approximately $131 billion in military and financial assistance. The reparations discussions should include requirements for Russia to pay the United States, EU, and other contributors back. 

Leverage the International Monetary Fund (IMF) and its existing channels for funding Ukraine. Just this week, the IMF moved forward with a $15 billion loan package for Ukraine, the first ever lending to a country at war in the seventy-seven year history of the institution. This significant step provides Ukraine with an amount nearing 10 percent of its total gross domestic product. Due to the existing transmission and oversight mechanisms between the IMF and Ukraine, the loan can be delivered and administered quickly. This is the kind of aid which can make an immediate difference, and more aid can—and should—be given through these existing channels. Further, Russian state assets could be used as a collateral on Ukraine’s IMF loans. 

Concerns with immediate confiscation of Russian state assets 

Legal obstacles cannot be dismissed. At a time when Western unity is key in countering Russian aggression, the potential value gained from seizing Russian state assets may not be worth the internal disagreements and tensions it would cause within the EU and the United States. EU member states can confiscate assets only if there is evidence of a specific criminal offense. This rule does not cover blocked sovereign assets. Seizing Russian state assets in this instance would require new legislation and while not insurmountable, gaining consensus among twenty-seven EU member states will be a challenging and lengthy process at a time when other coordination between Western allies is needed including on military aid.

Similar legal challenges exist in the United States. Former senior US officials and Atlantic Council colleagues argue that the United States has legal justification for moving forward with seizing Russian sovereign assets. They cite the implementation of the International Emergency Economic Powers Act (IEEPA) through Executive Order (EO) in 1992 in response to Iraq’s invasion of Kuwait. EO 12817 directed US financial institutions to transfer any Iraqi state funds they held to the Federal Reserve Bank of New York in compliance with a UN resolution, and to eventually disperse those funds to affected countries. 

However, this precedent does not apply today. In 1991, the United States Congress authorized the use of military force in the Gulf War consistent with a UN Security Council (UNSC) Chapter VII Resolution. It was “engaged in armed hostilities” with Iraq, triggering the IEEPA authorities that allowed the President to confiscate foreign-owned property. Today, the United States is not engaged in armed hostilities with Russia, Russia has not attacked the United States, and there is no UNSC Chapter VII Resolution because Russia and China hold veto power. These distinctions matter. While the moral case for transferring Russian sovereign assets now to support Ukraine is strong, the legal case is more nuanced. The legal challenges cannot be dismissed because they will potentially delay delivery of aid for years. 

Third-party states might perceive the United States as an unsafe destination for parking their reserves in the future. Meanwhile, Washington worries about discouraging other central banks from using the dollar as a reserve currency. That is one of the reasons why the Biden administration is resisting proposals from congressional lawmakers allowing seizure of sovereign assets in certain cases. Central banks choose locations for parking reserves based on a risk-based approach and their perceptions of how secure and accessible those assets are going to be. If non-Western countries are worried about getting sanctioned by the United States one day, they will work toward diversifying their portfolios with non-dollar and digital currencies. This could accelerate the recently emerged dedollarization trend and weaken the power of US economic statecraft tools in the future. While countries in the Global South have viewed the blocking of assets warily, it is likely they would view the seizing of assets as a significant escalation.

Private banks would likely be involved in the Central Bank of Russia (CBR) asset seizure process. In 2021, CBR held most of its reserves in the form of government securities. Currently, we don’t know the location of about two-thirds of the blocked $300 billion Russian state assets. There is a likelihood that at least a portion of these assets is still kept as government securities in European commercial banks. All of this will require extra steps and a new directive from the government to the private sector in any forfeiture action.

Georgia on the radar

Finally, let’s zoom in on a country we have never covered in the Global Sanctions Dashboard before: Georgia. Several days ago, experts in Washington called on the United States and Europe to sanction members of the ruling Georgian Dream party if they pass the proposed foreign agent law. The controversial draft legislation, which would require organizations to register as “foreign agents” if they received 20 percent or more of their funding from foreign donors, passed the first parliament hearing. This triggered massive protests in Tbilisi and the Georgian Dream, under pressure, stated it would pull the draft law. 

The draft legislation, based on a similar infamous law in Russia, is yet another sign of Georgia’s democratic backsliding under the rule of the Georgian Dream party. It goes against the aspirations of strongly pro-Western Georgian people and if passed, could tilt Georgia’s future away from the West and closer to the Kremlin. 

Although the Georgian Dream said that it will withdraw the draft law, many strongly pro-Western Georgians are continuing demonstrations to ensure the ruling party delivers on the promise. The situation in Tbilisi remains volatile, and whether we will see individual sanctions against Georgian Dream members may depend on how they vote during the second parliament hearing.

Castellum.AI provides sanctions data for the Global Sanctions Dashboard.

Global Sanctions Dashboard

The Global Sanctions Dashboard provides a global overview of various sanctions regimes and lists. Each month you will find an update on the most recent listings and delistings and insights into the motivations behind them.

Explore Here

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Global Sanctions Dashboard: What to do with sanctioned Russian assets appeared first on Atlantic Council.

The monetary-policy challenge cannot be overestimated.

Monetary policy basics

The Fed has a famous dual mandate that requires it to set interest rates that optimize price stability and full employment simultaneously over the medium term. In the most recent semi-annual monetary policy testimony to Congress on March 8, Federal Reserve Chairman Jerome Powell characterized the mandate as pursuing “our maximum-employment and price-stability goals.” 

But the Fed has two additional mandates that overlap with monetary policy at the margins: financial stability and managing payment-system access/operational integrity. During crisis situations, these additional mandates deliver the deciding factor for interest-rate policy.

The Fed is now in an unenviable position. Its monetary-policy and financial-stability mandates are at odds with each other. Raising interest rates would be justified—based on underlying economic theory pertaining to prevailing inflation rates and labor market strength—but doing so will generate additional stress on bank liquidity buffers. On the other hand, pausing or cutting rates will at least tacitly acknowledge that monetary policy intensified (if it did not cause) the current financial system stresses. 

The systemic stresses in play today are rooted in two specific details from the financial crisis in 2008.

The Global Financial Crisis and the high-quality liquid assets problem

One of the many Basel III reforms (enshrined into US law via the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act) involved creating a sensible requirement that banks hold more liquid assets. Banks were required to hold high-quality liquid assets (HQLA) so that they could meet liquidity needs by relying on capital markets rather than on possible government bailouts. The securities that most easily meet the definition of HQLA are US government bonds. 

Many policymakers solemnly vowed at the time that they would never again bail out a bank. Whether bailing out billionaire depositors (with deposits in excess of $250,000) is morally superior to bailing out bank shareholders should be debated separately. The bigger point is that this was not supposed to happen again.

There’s an HQLA problem—one that extends well past Silicon Valley Bank. The assets that banks hold may still be high quality, but the price and value of those assets have eroded significantly in the last year as interest rates increased. In addition, efforts to liquidate those securities at scale create other problems. Significant drops in price could potentially trigger risk limits at other banks, requiring them also to liquidate US Treasury bonds at fire sale rates.

A race to liquidate HQLA amid increasing interest rates while the Fed chases “maximum employment” would create much larger, undesirable financial system stresses. In other words, the run on Silicon Valley Bank at the start of March is actually the benign scenario. A sizable hole exists in bank balance sheets due to the erosion in value amid high and rising rates. The Federal Deposit Insurance Corporation’s data from the end of last year paints a somber picture:

The newly launched Bank Term Funding Program (BTFP) thus understandably tells banks not to sell their Treasury securities. Instead, the Fed promises to deliver to the banks liquidity support at par value (not the much-lower market value) against collateral in the form of… Treasury securities. The framework thus helps stabilize market prices for those instruments by suppressing sales.

Markets remain in a precarious position, as the coordinated central bank dollar-liquidity lines indicate. Many in finance will not be surprised. Within the first few days of operation last week, Reuters reports, banks utilized nearly half of the BTFP ($11.9 billion out of the available $25 billion)—and they had acquired additional liquidity support through the Fed’s discount window facility at a historic level. 

This is the first time this century that the discount window has been tapped at scale without a recession also being present. Treasury markets also came under stress last week.

The United States approaches this period of financial uncertainty with a booming economy and a booming labor market. However, data showing continued strength regarding inflation, the labor market, and gross-domestic-product growth all require a data-dependent Federal Reserve to continue hiking interest rates. More interest rate hikes will further erode the value of HQLA on bank balance sheets globally.

The Fed seems to have boxed itself into a corner, creating cross-border financial instability that tarnishes US leadership. From Europe to Japan, economies were emerging from the pandemic with a soft landing in their sights. If the HQLA situation triggers further instability and damages the global recovery, many policymakers may begin to question US economic leadership.

Barbara C. Matthews is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center. While in government, she served first as senior counsel to the House Financial Services Committee and then as the Treasury Department’s first attaché to the European Union. She is currently the founder and chief executive officer of BCMstrategy, Inc.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post The Federal Reserve’s dilemma: Choosing between monetary policy and financial stability appeared first on Atlantic Council.

The ECB was the first major central bank to make a move during the crisis when it decided to raise key policy rates by fifty basis points (or half a percentage point) on March 16—consistent with its pre-crisis plan. President Christine Lagarde explained that the ECB will continue to focus on bringing down inflation to its medium-term target of 2 percent, making use of the interest-rate instrument to do so. The ECB, she added, will also closely monitor market tensions and be ready to use its policy toolkit to supply liquidity to the financial system if needed.

Several commentators, in particular former US Treasury Secretary Larry Summers, praised the ECB not only for raising rates as planned in the face of financial market turmoil but also for delineating monetary policy from financial stability concerns. “Lagarde gets an A+ today,” Summers said. Basically, in this delineation, monetary policy mainly uses interest rates to keep inflation under control, while financial stability problems can be addressed by another set of instruments including financial regulation and supervision, liquidity support, deposit insurance, and closing or staging buyouts of banks. This separation of policy goals and instruments is conceptually appealing, avoiding the problem of trying to use one instrument to serve multiple policy objectives.

Unfortunately, reality is too complicated and interconnected to allow such a clear-cut separation. Essentially, interest rates influence behaviors throughout the economy and financial markets. Or as then Fed Governor Jeremy Stein said ten years ago: monetary policy “gets in all of the cracks.” As a result, central bank interest-rate policy strongly influences financial behaviors, especially the appetite for risk. Low rates for long periods of time, as has been the case from the 2008 global financial crisis to the COVID-19 years, prompt a frantic search for yield, leading to an overvaluation of financial assets and elevating financial stability risks.

Subsequently, when inflation rises and central banks raise interest rates, this will create losses in fixed-income instruments and other assets, tightening financial conditions and slowing economic activity. If the volume of bonds accumulated by banks and other financial institutions is significant, the losses—both realized and unrealized—will also be uncomfortably large. These losses, coupled with slowing business activity, will be destabilizing to institutions with unstable funding bases.

Indeed, this is what has recently transpired in the United States. A combination of unrealized bond losses and generally unprofitable businesses, together with unstable funding, have brought down Silicon Valley Bank and Signature Bank and put severe pressure on First Republic Bank and several others in similar circumstances. US authorities have guaranteed large deposits at the two failed banks, launched the Bank Term Funding Program to lend against banks’ high-quality bond portfolios at face value (to avoid mark-to-market losses) for up to one year, and strengthened currency swap lines with five other major central banks to provide adequate supply of US dollar funding to foreign banks. In Europe, the Swiss authorities have moved quickly to broker a buyout by UBS of the inherently weak and unprofitable Credit Suisse, offering substantial liquidity support and guarantees of losses.

These actions have addressed the problems identified at specific institutions, but banking systems worldwide remain under market pressure: They still face the same underlying challenge of high interest rates. Moreover, pouring liquidity into the banking system would contradict to a large extent central banks’ effort to keep raising rates, while causing uncertainty in financial markets. Moreover, this crisis episode has shown that regulatory and supervisory tools are imperfect and unable to address financial stability concerns on a timely basis—in part due to the backward-looking nature of regulatory ratios. For example, Credit Suisse maintained its capital adequacy and liquidity coverage ratios above the levels required by Basel III launched in the wake of the 2008 crisis to the day it was acquired by UBS.

More importantly, by not doing enough to prevent crises, allowing them to materialize, and then trying to pacify markets with crisis management tools, central banks have inflicted substantial costs on society as a whole. Central banks’ reputation and legitimacy have also suffered—and will even more if their crisis management is not executed perfectly.

At present, market participants expect central banks, in particular the Fed in its March 22 Federal Open Market Committee meeting, to adjust their tightening strategy. After all, the banking crisis has caused a significant tightening of financial conditions, which is what central banks try to do by raising rates. Specifically, markets expect the Fed to either raise rates by twenty-five instead of its planned fifty basis points or pause tightening, with a rate cut likely to come later this year. Under the currently unsettled circumstances, the stakes are high: Disappointing market expectations could usher in additional selloffs in financial markets, especially of bank shares and bonds, possibly requiring more bailouts. On the other hand, the Fed needs also to communicate its intention to bring inflation back to its target in the medium term—a difficult but not impossible thing to do.

Going forward, central banks should be more transparent in explaining how they take into consideration the impacts of excessive risk taking as well as banking and financial crises when formulating monetary policies—both during the easing and tightening phases. It is difficult for central banks to balance controlling inflation with preserving financial stability, but that is no excuse not to try to the best of their judgement. Given what has happened, simply repeating the mantra that monetary policy is for dealing with inflation while regulatory and supervisory tools are for financial stability is doing a disservice to all stakeholders of the financial system.

Hung Tran is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center, a former executive managing director at the Institute of International Finance, and former deputy director at the International Monetary Fund.

The post Central bankers must keep financial stability in mind as they fight inflation appeared first on Atlantic Council.

Debt limits—which act as a ceiling on the central government’s ability to borrow money to finance existing legal obligations—are self-imposed. They are not a legal obligation to any lender. Ceilings are often intended to signal fiscal discipline to international investors or to enact checks and balances on a country’s public finances. But investors rarely like them because they can be easily skirted, making them a mild irritant. Worse, they can trigger full-scale political chaos and directly jeopardize investments.

In the United States, debt limits are set as a nominal value. Two important pieces of legislation concerning the debt limit were adopted during World War I in 1917 and right before World War II in 1939. The ballooning and unknowable costs of war and the intervening economic depression made it cumbersome for Congress to oversee each instance of debt issuance. Congress therefore gave the US Department of the Treasury considerable flexibility on the issuance and management of debt—while imposing a ceiling on total debt. Since 1960, Congress has permanently raised, temporarily extended, or revised the definition of the debt limit seventy-eight times under both Democratic and Republican presidents. 

Many of these negotiations have been fraught with political deadlock, leading to serious concerns over a possible default on US debt obligations. Hitting the debt limit could paralyze the government’s ability to finance its operations—including national security initiatives, Medicare, and Social Security. It could result in a downgrade from credit rating agencies, making borrowing more expensive for the public sector, private sector, and households alike. It could also shake the dollar’s foundations, threatening its centrality in the global economy. Even the mere prospect of any of this happening worries global investors.

Debt limits like the United States’, however, are not the norm—and they rarely cause major deadlocks in the few countries that have adopted this tool. Other countries have avoided deadlocks through one of these four routes: 

1. The ceiling is intentionally set sufficiently high such that it will not plausibly be crossed.
2. The law is either amended or suspended during periods of heightened stress necessitating indebtedness.
3. No punishments are tied to the legislation, meaning states often cross the limit with impunity.
4. The law was scrapped altogether when it was severely curtailing the government’s policy space.

How do other countries manage debt limits? 

Denmark

Like the United States, Denmark also sets its debt limit as a nominal value. But that’s where the similarity ends. The Danish Parliament intentionally sets the ceiling sufficiently high such that it will not be crossed, rendering it no more than a formality.

The Danish Parliament first passed debt ceiling legislation in 1993 as a constitutional necessity resulting from administrative reorganization of government institutions. Since then, the debt limit was amended just once in 2010, when the country’s debt remained far under the limit. The ceiling was doubled to DKK two thousand billion or 115 percent of 2010 Danish gross domestic product (GDP), far higher than actual debt levels. Denmark’s outstanding general government debt in 2023 is DKK 327 billion, which is only 16 percent of the debt ceiling. The 2010 doubling was executed with the explicit intention of avoiding any risk of nominal gross debt ceilings affecting ongoing fiscal policies in response to the 2008 recession.

Kenya

Like the United States and Denmark, Kenya also has a nominal debt limit. However, it is under the process of replacing the nominal limit with a limit as percentage of GDP at 55 percent. The intention is to make debt management more sustainable—or in other words, to finance budget deficits in the medium term without needing to repeatedly negotiate the debt limit.

The government has typically stayed within the constraints of debt limit legislation. But when push came to shove, the Parliament of Kenya has increased the limit in advance to avoid an economic impasse. Parliament recently increased the debt limit from KES nine trillion to KES ten trillion to enable complete financing of the 2022 / 2023 budget. The legislation had a majority in parliament. Opposition from a few members of parliament leading up to the limit raise had less to do with political infighting, and more to do with concerns regarding vulnerability to debt distress. This raise is nevertheless understood to be an interim measure while Kenya moves to debt limits as a percentage of GDP.

European Union 

The European Union (EU) joins the United States as the only other Group of Twenty member to stipulate a formal debt limit—albeit of a different type. The EU’s Stability and Growth Pact (SGP) stipulates that a member’s debt cannot exceed 60 percent of its GDP. If a state breaches that ceiling, the excessive debt procedure (EDP) is automatically launched by the European Commission. It consists of several steps—culminating in sanctions—that intend to pressure the state to return to that 60 percent figure. This debt limit is meant to safeguard the stability of the common currency. 

The EU’s debt limit legislation imposes strict penalties on transgressors, but exhibits adaptability to extreme economic duress. The legislation includes a “general escape clause” which can only be triggered in a severe economic downturn. It was triggered in response to the pandemic in 2020 and has yet to be reinstated. The EU is now actively exploring fiscal reforms including the debt limit, particularly to help countries implement the green and digital transitions, meaning the debt limit may not return in its current form.  

Poland 

Within the EU, Poland also has domestic laws to limit debt. Constitutional articles stipulate that national public debt cannot exceed 60 percent of the annual GDP. Here too, the law has shown flexibility to circumstance.For instance, some of the toughest measures to manage debt levels were suspended to facilitate response to the economic slump in 2013. 

Malaysia 

Malaysia’s debt limit is set at 60 percent of GDP, lifted from 55 percent in 2020 to aid the government’s response to the pandemic. It was lifted further temporarily to 65 percent of GDP in 2021 to make room for additional borrowing and fiscal stimulus, and this temporary provision lapsed on December 31, 2022. Unlike the United States, the debt limit is not governed by any act and is self-imposed by the Ministry of Finance. Parliamentary approval is not necessary to raise the debt ceiling and the government will not “shut down” in the event of exceeding the limit. The government can simply revise the limit when needed. Subsequent governments have nevertheless remained approximately within bounds of the debt limit. Now that the limit has returned to 60 percent following the temporary raise to 65 percent, the Malaysian prime minister has assured that the government will gradually lower the nation’s debt and return within bounds of the debt limit.

Namibia

The Namibian debt ceiling is set at 35 percent of its GDP. However, this figure is non-legislative and the Namibian debt-to-GDP has been above that level for years. In 2021, Namibia’s debt was 72 percent of its GDP.

The Namibian government has attempted to return to that 35 percent figure. It has cut its national budget and created a sovereign wealth fund. These efforts, however, have been severely hampered by government spending during the COVID-19 pandemic and food shortages resulting from the war in Ukraine. 

Pakistan

The Fiscal Responsibility and Debt Limitation Act of 2005 requires the Pakistani government to reduce total public debt to 60 percent of GDP by 2018. But the legislation does not stipulate any punishment for breaching that limit. Without an incentive to stay under it, Pakistan’s debt has continually been over the limit. The debt-to-GDP ratio this fiscal year is 75 percent. 

Limitations of the debt limit

Australia briefly experimented with a debt limit similar to that of the United States, experienced the political infighting that Washington is familiar with, and abolished it soon after. In response to the Global Financial Crisis, the government introduced a debt ceiling of AUD seventy-five billion in 2008 to signal its commitment to fiscal prudence. But deficits persisted, and the government raised the ceiling multiple times to staunch resistance from the opposition, culminating at a limit of AUD three hundred billion. When the new government in 2013 was met with strong resistance to increasing the limit yet again, it ultimately decided to scrap the law altogether. 

Debt limits are self-imposed tools to facilitate sound fiscal policy. But in practice they serve as orienting goals or tools of political bargaining at best, and triggers of economic chaos at worst. It is unsurprising that most of the world chooses to have no such limit.

The United States is one among the few polities that have adopted and retained debt limits. Within that tiny group, it is unique in its inability to find workarounds which could inadvertently harm its national interest.

Mrugank Bhusari is an assistant director with the GeoEconomics Center focusing on international finance and global governance. Follow him on Twitter @BhusariMrugank.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post The US debt limit is a global outlier appeared first on Atlantic Council.

The post Lipsky quoted in AFP Fact Check debunking the idea that CBDCs caused the crash of the Silicon Valley Bank appeared first on Atlantic Council.

But if you look past the surface, it’s clear that 2023 bears little similarity to 2008. The international financial system is much stronger today thanks to the lessons learned over the past decade—and that’s why this time policymakers stand a much better chance of containing the fallout.

Here are two key differences between now and then:

1. Moving fast, moving forcefully

In the period between Bear Stearns collapsing in March 2008 and Lehman Brothers going under that September, there was continuous handwringing in Washington and around the world about what to do. Debates on moral hazard, contagion, and how to use taxpayer money to save the financial sector consumed that entire summer. Many wanted to believe that Bear Stearns’s problems were the result of bad management and a failure to hedge against risk. At the time some analysts said the fallout would be limited. Sound familiar? By the time the Federal Reserve (Fed) and Treasury convinced Congress that the problem was systemic, it was almost too late.

This time around, policymakers took action quickly. Last Sunday the Fed, Treasury, and the Federal Deposit Insurance Corporation moved swiftly in response to Silicon Valley Bank’s failure. They surprised many with a complete protection for all of the bank’s depositors and a guarantee of one year of loans to other financial institutions.  While some have understandably criticized the move (including US senators who grilled Treasury Secretary Janet Yellen on Thursday), it’s clear that the decision calmed markets and stabilized the situation for other banks.

Switzerland was paying attention. On Wednesday, as shares of banking giant Credit Suisse traded at record lows, the Swiss National Bank pledged a fifty-four-billion-dollar financial lifeline. To put that in perspective, the entire gross domestic product (GDP) of Switzerland is around eight hundred billion dollars. So the commitment of its central bank amounts to nearly 7 percent of the country’s GDP. The entire amount accessed under the Troubled Asset Relief Program in the United States—the largest financial rescue plan ever authorized—amounted to slightly more than 3 percent of US GDP.

Now comes the European Central Bank (ECB). Its president, Christine Lagarde, was a key player in 2008, serving as French finance minister and coordinating on a plan of action with then US Treasury Secretary Hank Paulson. So it should be no surprise that Lagarde and the ECB didn’t blink in today’s meeting. The governing council raised interest rates by half a percent, as expected, and sent a signal to markets that the ECB was fully prepared to step in and support the euro area banking system if needed. But she reminded reporters, “I was around in 2008, so I have clear recollection of what happened and what we had to do, we did reform the framework… And I think that the banking sector is currently in a much, much stronger position than where it was back in 2008.”

The bottom line is that instead of waiting to see what unfolds, central banks are being decisive.

2. More money, fewer problems

One of the challenges of 2008 was understanding the size of the problem. In the chaos of Lehman’s collapse, banks and regulators were scrambling to figure out just how many ‘toxic’ assets other banks held on their balance sheets. This time a similar effort is under way, but the problem is far less complex. These institutions are not dealing with mortgage-backed securities but instead US Treasuries—arguably the safest investment on the planet—and therefore it is much easier to find someone willing to step in and buy them up. That simply wasn’t the case last time around.

Meanwhile, thanks in part to the Dodd-Frank legislation that raised capital requirements for banks, the largest financial institutions have more money on hand to deal with potential problems. The charts below help show the difference from 2008:

The total deposit amount and the loan/deposit ratio in the overall US banking industry is extremely healthy. As we have seen, however, that doesn’t mean regional banks are going to emerge unscathed. It’s already clear that depositors want to move their money from smaller banks to bigger banks, and we can expect that trend to continue in the months ahead. In 2018, changes to Dodd-Frank exempted many regional banks from the kind of oversight that may have mitigated the current problems. Now, as regulators step up their oversight of mid-sized banks, the short-term result could be more regional banks having to shutter their doors. This will create domestic economic headwinds and presents its own problems of too much concentration of capital in the largest banks—but it is not a threat to global financial stability.

The data show that there is much more money in the system right now than there was in 2008, and there’s a huge market available for banks that are trying to resolve problematic parts of their balance sheets. It’s night and day from the abyss that confronted bankers and regulators in the fall of 2008.

At the end of the day, banking is about confidence. Customers need to have faith that their money is safe. Citizens need to be assured that their governments have a plan. It would be a mistake to hesitate, thereby sowing doubt in the markets and creating a problem worse than the one that actually exists.

Josh Lipsky is the senior director of the Atlantic Council’s GeoEconomics Center and a former adviser at the International Monetary Fund.

The post It’s not 2008: Keep calm as central banks carry on appeared first on Atlantic Council.

As governments around the world weigh this crucial question, deciding whether to help failing banks first requires clarifying what exactly a bailout entails.

Take the most recent example. In the last week, US financial authorities moved promptly to guarantee all deposits of the two closed banks (SVB and Signature) thus trying to avoid turmoil in financial markets and the high-tech business sector in particular. In addition, the Federal Reserve (Fed) has launched a Bank Term Funding Program (BTFP) to lend to banks against high-quality bonds as collateral for up to one year, at face value instead of market value, which has been eroded due to rising interest rates. This has ignited a growing debate about whether protecting all depositors of the closed banks represents a bank bailout and whether it is justified.

Is it a bailout?

US President Joe Biden, the Federal Reserve, and US financial regulators have insisted that the measures adopted on March 12 do not constitute a bailout of the closed banks—since their shareholders and bondholders are exposed to losses potentially wiping out all their claims. Taxpayers’ money is not involved and, they argue, will not be lost as the deposit protection will be funded by selling the assets of the closed banks. However, this assertion is weakened somewhat by the fact that the Federal Deposit Insurance Corporation’s (FDIC) $125 billion insurance fund and $25 billion from the Treasury Departments’s Exchange Stabilization Fund will be available as a backup.

In turn, critics of these moves point out that protecting large depositors who are supposed to be at risk is bailing them out of the consequences of their actions, and in the process weakens market discipline and elevates moral hazard. After all, public resources are involved in the sense of allowing the Fed and the FDIC to use their balance sheets and buy time to go through the resolution process. If the FDIC’s fund is used, it will have to be replenished by assessments on all banks—so all the banks and their customers, meaning society at large, will have to pay.

Was the ‘bailout’ justified?

The answer to this question depends on distinguishing the short term from the long term. In the short term, the answer is “yes” simply because of the bleak consequences of the alternative. Not protecting all depositors of the failed banks would risk spreading the bank runs to other banks perceived to be in similar circumstances or weak in some ways, then to much of the banking system. This risks destabilizing the whole economy and inflicting tremendous costs on citizens.

The problem is that all crises require short-term responses, and repeated rescue operations, especially since 2008, have hard-wired these expectations and behaviors into financial market participants. When things go wrong, the government will come to the rescue without fail. As a result, moral hazard is no longer a theoretical concern. It is alive and well.

Another set of expectations has also become hard-wired in financial markets. A crisis usually triggers a kind of “New Year’s resolution” to implement financial regulatory reform to make the system healthier and more resilient in the future. That resolution may or may not go anywhere—most of the time not—but even when it does produce results, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the reform was later rolled back when things settled down.

In short, especially since 2008, the US financial system has morphed into one where any crises or stressful periods have been ‘competently’ pacified by the Fed—either by flooding the financial markets with ample liquidity or offering outright guarantees or protection to the market participants at risk. Naturally, when things go well, the owners of financial assets and senior managers of financial institutions—a small minority of the population—reap most of the benefits.

The long-term problem is that such a financial system is anti-capitalistic (Adam Smith would be turning over in his grave), inequitable, and unsustainable. The longer it persists, the more it undermines the legitimacy of the Fed and other financial regulators—and of the government as a whole.

Was there a better option?

According to SVB’s latest balance sheet, at the end of December the bank had assets of $211.8 billion, of which presumably high-quality bonds (US Treasury bonds, agencies, and mortgage-backed securities) amounted to $116.7 billion, net commercial loans made up $73.6 billion, and other assets making up the rest. The bank also had $173.1 billion of total deposits, of which $163.2 billion were uninsured and $132.8 billion were demand deposits. In addition, SVB has $19.3 billion of total debt and $16.3 billion of total equity.

Instead of offering a blanket guarantee to all large depositors, a much better approach would have been to protect large depositors up to the value of the closed banks’ high-quality bond portfolios, which are eligible as collateral to borrow from the newly launched BTFP. The limit could be the market value of the bonds (in which case there is no implicit public support involved); or their face value (in which case the BTFP provides a service by warehousing the bonds until maturity without realizing any losses). SVB’s bond portfolios at face value would have paid $116.7 billion out of the $163.2 billion uninsured deposits—leaving $46.5 billion uncovered. These “excess” deposit claims would have to wait to get paid from the sale of the remainder of the bank’s assets of $95.1 billion; either fully or partially depending on the outcome of the liquidation efforts. This is not a bad cushion as debtholders and shareholders will be the first to take losses.

This procedure would enable large depositors, presumably high-tech start-up companies in the case of SVB, to get money to carry on normal business without serious disruptions. But, critically, it would also subject them to some degree of market discipline. Hopefully, they would then be incentivized to shop around for banks with a healthy holding of high-quality bonds, in the process generating competitive pressure on the banks to do so to the benefit of their safety and soundness.

If more banks start to fail, regulators should use this approach with large depositors to help protect the economy without resorting to more bailouts.

Hung Tran is a nonresident senior fellow at the Atlantic Council, a former executive managing director at the Institute of International Finance and former deputy director at the International Monetary Fund.

The post Bailouts create a moral hazard even if they are justified. Is there another way? appeared first on Atlantic Council.

The post Mohseni-Cheraghlou and Aladekoba cited in South China Morning Post on Chinese military exports to Sub-Saharan Africa appeared first on Atlantic Council.

The post Tran’s article on the Silicon Valley Bank fall out featured in Formiche appeared first on Atlantic Council.

The post Lipsky quoted by Los Angeles Times about the reasons for collapse of Silicon Valley Bank appeared first on Atlantic Council.

The post Lipsky quoted by Vox on how the Silicon Valley Bank did not receive an actual bailout appeared first on Atlantic Council.

From what is known so far, the cause for SVB’s demise was a classic asset-liability duration mismatch. The bank held a large portfolio of long-term bonds that had lost in market value as interest rates increased over the past year. As word began to spread about its weak financial situation, it did not have enough short-term liquidity to meet customers’ demands for deposit withdrawals. The bank was then forced to sell its assets and realize its losses, which eventually led regulators to step in.

With the Fed’s tightening cycle still in full swing, it stands to reason that SVB—the sixteenth largest US bank with $209 billion in assets at the end of 2022—is not the only bank or financial institution to experience maturity mismatches of this kind. FDIC Chair Martin Gruenberg cautioned last week that the US financial system carries a $620 billion risk from value losses in bond portfolios. Much of this may be spread across smaller financial institutions, but it remains to be seen how other banks are able to cope with valuation losses on their balance sheets.

While SVB’s failure did not portend a systemic financial risk, given the specialized nature of its business, its troubles posed an existential threat to many start-up companies. These companies have held most of their deposits with the bank, and significant losses or an inability to access liquid funds could have jeopardized their ability to pay for ongoing operations. The concern was that widespread failures in the start-up sector could have had detrimental consequences for the pace of technological innovation and economic growth in future years. While Silicon Valley appeared to be hit hardest, SVB also owned branches or subsidiaries in countries around the world. Pressures duly emerged in Canada, the United Kingdom—where HSBC took over Silicon Valley Bank UK on Monday—and South Korea, for example.

Where does this leave policymakers at the current juncture?

• Immediate steps. US regulators, the Federal Reserve, and the US Treasury moved quickly over the weekend to protect depositors, restore access to SVB customers’ funds, and ensure that the SVB failure would not lead to a wider crisis of confidence in the financial sector. Unlike 2008, the bank’s failure stemmed from bond valuation losses, not failed loans. This leaves a considerable amounts of assets to cover losses while the balance sheet is being unwound, keeping overall rescue costs low. The FDIC had also invited bids from other banks to take over SVB’s business, but no buyer emerged over the weekend.
• Addressing systemic risk. The Federal Reserve also announced the creation of a new Bank Term Funding Program as a source of liquidity that could help financial institutions to avoid fire sales in times of stress, backed up by twenty-five billion dollars from the US Treasury’s Exchange Stabilization Fund. Financial markets recovered after the announcement but, in an echo of the 2008 global financial crisis, these actions could be politically contested. By extending deposit protection to banks’ commercial customers, regulators could be accused of encouraging additional risk-taking at public expense. Given the concentration of losses in the US technology sector, however, the intervention seemed justified. Regulators now need to hold managers accountable and ensure swift intervention and resolution of failed banks going forward.
• Bank regulation. Experts and former officials are asking why bank supervisors did not detect SVB’s problems at an earlier stage, allowing it to operate until a deposit run forced an intervention mid-week (similar to the recent case of Silvergate Capital, a smaller bank tied to the bankruptcy of crypto firm FTX). Best practice would have been to intervene over a weekend to avoid deposit runs, minimizing bank losses and effects on market confidence. While supervisors were quick to shut down Signature Bank, a smaller bank with ties to the crypto industry, over the weekend, they have been hampered by the fact that smaller banks became subject to less intense supervision with the 2018 revision of the Dodd-Frank Act. Whether legislative efforts are needed to tighten regulations will surely become a point of contention going forward.
• Crypto companies. In a twist highlighting the close relationship between the traditional financial and crypto universes, stablecoin issuer Circle* has also been affected by the closure of SVB, which held about three billion of its forty-two-billion-dollar asset base. Circle’s US dollar coin was trading as much as 15 percent below parity on Friday but recovered over the weekend after the company pledged to cover any shortfall in assets. The episode highlights the fragility of the business model behind stablecoins, even for a company that has a reputation of working closely with regulators. Circle’s quick response appears to have averted further damage even before it regained access to its deposits, but the onus is on the US Securities and Exchange Commission and other regulators to ensure that stablecoins are fully backed by liquid and high-quality assets.

The SVB episode is likely a harbinger of greater market volatility as the Federal Reserve continues to tighten monetary policy, even in the absence of a full-blown recession. While interest rate increases could slow down in the case of financial fragilities, the Fed is in a bind as long as inflation remains at current levels. The 2008 crisis has provided regulators with important lessons, but the end of a decade-long period of ultra-low interest rates clearly carries the potential for significant disruptions, including in the large nonbank financial sector. Economic agents have always been caught out by shifting monetary policy paradigms, and this time will be no different.

Risks are not limited to the United States, of course. Europe is undergoing its own tightening cycle, with the European Central Bank caught between stubborn inflation and some highly indebted euro area member countries. China is grappling with slow growth and a real estate crisis, emerging markets are under strain from a strong dollar, global trade restrictions are on the rise, and so are geopolitical tensions with China and Russia. Cryptocurrencies and cyber risks have introduced another element of uncertainty and possible contagion, as the SVB event has demonstrated. In this volatile environment, it may take less than a Lehman Brothers-sized shock to cause severe financial and economic disruption. Governments and central banks around the world better be prepared.

Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former International Monetary Fund chief of staff.

Note: Circle is a donor to the Atlantic Council.

The post The Fed’s tightening is a recipe for global volatility. Silicon Valley Bank’s collapse is just the start. appeared first on Atlantic Council.

At the same time, the Fed announced a new Bank Term Funding Program (BTFP) designed to lend to banks and other depository institutions for up to one year against high quality collateral such as US Treasuries, agencies, and mortgage backed securities, at their face values instead of market values. The BTFP will be backstopped by $25 billion from the Treasury’s Exchange Stabilization Fund (ESF)—in addition to the Federal Deposit Insurance Corporation (FDIC) fund of $125 billion, which has been paid in by banks as insurance premiums.

They also emphasized that all depositors at the two closed banks will have access to their deposits. Presumably, the closed banks have sufficient collateral to borrow from the new program to pay off all depositors. However, it is highly likely that share and bond holders will have to take haircuts in the resolution of the closed banks. Prompt actions by regulators enable startup companies to have access to their deposits at SVB to continue functioning. But they have failed to stabilize financial markets in the United States and globally.

The launch of the BTFP aims to help banks make full use of their US Treasury portfolios—without realizing mark-to-market losses—in order to payoff large depositors exceeding the $250,000 FDIC limit per account, per bank. The BTFP thus buys time for the Treasury collateral to regain par value at their maturity, allowing the authorities to claim that taxpayer money will not be involved in the resolution of the failed banks. Nevertheless, “buying time” represents rescuing banks from the marked-to-market losses on their high-quality bond holdings; and the public fund from the ESF is being used as a back-up. As a result, there will likely be criticism and protests from politicians opposed to bank bailouts following the 2008 financial crisis.

The announced emergency measures have failed to stabilize markets, with participants now looking for the Fed to ease off on its tightening regime, which is the root cause of the difficulties at the failed banks. Fed action remains to be seen, but events in the past week have already raised important questions which have to be addressed going forward.

Most immediately, what will happen if a bank under liquidity pressure does not have enough high-quality bonds to use as collateral—even at par value—to borrow money to pay off large depositors? Will the Fed relax the current rules and allow the BTFP to accept less than high-quality bonds (such as corporate bonds) as collateral. Will it require large depositors to accept less than their full amount? This uncertainty will keep depositors on edge and encourage at least some of them to move to strong banks in a flight to quality.

Secondly, the efforts to protect large depositors have put the US banking system on a slippery slope of socializing the deposit-taking business of banks, creating huge moral hazard. The risk is that, under the pressure of financial market turmoil and business disruptions, authorities will keep relaxing the conditions for lending to failing banks to help them pay off all depositors. It is important to realize that protecting all bank deposits would be hugely costly either in terms of necessary insurance premiums charged to banks or using public funds. Ideally, a clear limit for deposit insurance protection needs to be drawn. Above this limit, large depositors will need to be paid only from the liquidation proceeds of their failed banks. A precedent for this is the case of IndyMac, which failed in 2008. Its large depositors took a 50 percent haircut at that time, and were required to wait for potential residual payments later on.

Thirdly, authorities need to explore ways to minimize the detrimental effects of marked-to-market losses on the huge volume of bonds held by banks and other financial institutions during the long period of near-zero interest rates. The FDIC has estimated that unrealized losses on those bond holdings amounted to $620.4 billion at the end of 2022—more than doubling US banks’ net income of $263 billion in 2022. Presumably the unrealized losses would weigh more heavily on banks with inadequate risk management practices. However, while hedging can reduce interest rate risks—and losses—of individual banks, the risk and potential loss remain in the whole banking system.

Banks can put a portion of their bond holdings in “held to maturity” (HTM) accounts, in which case those positions don’t need to be marked to market. The theoretical marked-to-market losses on the HTM accounts amount to about $300 billion but will be protected by the BTFP. If banks put them in “available for sale” accounts, they must be marked-to-market and the resulting valuation losses charged against equity capital. As mentioned above, US banks—especially the systemically important ones—are better capitalized (with Tier 1 risk-based capital ratio of 13.65 percent at the end of 2022) compared to the 2008 situation. They can therefore absorb these valuation losses. Nevertheless, the unrealized losses would reduce banks’ propensity to extend credit—contributing to a tightening of financing conditions and slowing economic activity. In particular, the high-tech startups sector will experience growing funding difficulties in the foreseeable future. This sector is currently needed to sustain the US lead in its competition with China. The unrealized losses could also interact with deposit outflows to hobble segments of the banking system.

Fourthly, in the past year during which the Fed has raised rates, bank customers have moved about $500 billion of deposits from banks to money market mutual funds (MMMFs) offering higher yields. This shift is especially thanks to the fact that MMMFs can conduct reverse repo transactions with the Fed at 4.55 percent at no credit risk. Banks have had to compete by raising rates to attract deposits, including by issuing a growing volume of Certificates of Deposits. However, this has cut into their interest margins, reducing earnings going forward. More importantly, banks perceived to be weak would have suffered more deposit withdrawal. This “flight to quality” would accelerate now as clients scramble to diversify their deposits to stronger banks even with the recently announced measures—keeping segments of the banking system unstable.

Finally, most of the US banking system is not subject to the full force of the Dodd-Frank regulations. In 2018 President Trump signed into law deregulation legislation designed to exempt banks with assets less than $250 billion (the previous threshold was $50 billion) from the full application of the Dodd-Frank regulations—such as strict reporting requirements and stress tests. Consequently the full Dodd-Frank regulatory and supervisory regime only applies to the twelve largest US banks with assets more than $250 billion. The rest of the 4,706 strong banking system has been exempt. At present, it is not clear how rigorously most of the US banks have been supervised in the past few years, or how long it would take for supervisors to screen these banks to identify vulnerable ones and take precautionary measures. But the sooner they can do this, the better. More importantly, there should be an earnest debate to change the 2018 law to bring more banks back into the full Dodd-Frank regulatory and supervisory processes.

Besides interest rate risks which have crystalized into losses on bond portfolios, credit risks and losses threaten to move to the fore as the US economy slides toward recession. Of particular concerns are highly-leveraged loans packaged into collateralized loan obligations and commercial real estate loans—as identified in the Fed’s latest Financial Stability Report. These products have been distributed widely to banks and non-bank financial institutions such as pension funds, insurance companies, and investment funds. Similar to banks with weak funding bases, according to the Fed’s latest Monetary Policy Report, “prime and tax-exempt money market funds, as well as many bond and bank loan mutual funds continue to be susceptible to runs.” Consequently, these financial stability risks need to be dealt with as well.

In conclusion, even if the contagion effects of SVB, Silvergate Financial, and Signature Bank failures can be contained—still a big if—risks to the financial stability of the United States, and the world by extension, have increased significantly. The Fed no longer has the luxury to focus only on bringing down inflation. It must also avoid exacerbating financial stability risks. At the same time, the regulatory community should work with Congress to reform and strengthen the financial regulatory framework given the obvious weaknesses revealed over the past week. The current social and political polarization will undoubtedly make this exercise difficult—but it needs to be done.

Hung Tran is a nonresident senior fellow at the Atlantic Council; a former executive managing director at the Institute of International Finance and former deputy director at the International Monetary Fund.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Silicon Valley Bank failed: What happens next? appeared first on Atlantic Council.

The post Tran cited by Munich Security Report 2023 on potentials for friendshoring appeared first on Atlantic Council.

The Atlantic Council’s Eurasia Center is exploring the issue of Russian threats to global financial security, beginning with a virtual event on February 8 moderated by Ambassador John Herbst and featuring Ukrainian Minister of Finance Serhiy Marchenko along with a panel of international experts.

Minister Marchenko began the event by reminding viewers that “for too long, Russia has been allowed to undermine the system from inside.” Ignoring the challenges that Russia’s misuse of the rules-based international order pose will only make this problem worse, he warned.

Subscribe to UkraineAlert

As the world watches the Russian invasion of Ukraine unfold, UkraineAlert delivers the best Atlantic Council expert insight and analysis on Ukraine twice a week directly to your inbox.

• Name
  First Last
• Email*
• 
  
  
• Comments
  This field is for validation purposes and should be left unchanged.

Since 2014, the West has sanctioned an expanding list of Russian industries and entities in response to violations of international law. Unprecedented additional sanctions were imposed following Russia’s full-scale invasion of Ukraine in 2022. However, the available sanctions options are not yet exhausted. “Sanctions are having an impact on the Russian economy,” said panelist Brian O’Toole, nonresident senior fellow at the Atlantic Council’s GeoEconomics Center, “but there is still plenty more to be done.”

Russia has created an international network to avoid sanctions and flout the rules governing the global financial sector. This network includes not only Russia’s Wagner Group, which was recently sanctioned as an international criminal organization by the US State Department, but also “the Taliban, Hezbollah, [Syria’s] Assad regime, North Korea, and Iran,” said Marchenko.

“Countless investigations have uncovered Russia’s complicity in money laundering,” reported Marchenko. He noted that Russia’s dependence on illicit financial activity through its network of allies has only increased since the imposition of sanctions.

For Timothy Ash, senior sovereign strategist at Bluebay Asset Management, sanctions are just the beginning of the process of extricating Russian malign influence from global institutions. Moscow is “corrupting [global] systems from within,” while Moscow’s international partners help “regime money exit and then be deployed in Russian state interests,” said Ash.

Eurasia Center events

Online Event Thu, July 20, 2023 • 8:00 am ET

After Vilnius: What’s next on Ukraine’s path to NATO?

Eastern Europe NATO Security & Defense Ukraine

John Cusack, founder of the Global Coalition to Fight Financial Crime, noted that “Russia has been gaming the system for more than two decades.” In the case of one global institution, the Financial Action Task Force (FATF), which was set up to police international money laundering, he claimed Russia’s role has run directly counter to the goals of the institution. Cusack accused the Kremlin of weaponizing its standing in the FATF to “[go] after people they don’t like.”

To respond to Russia’s flagrant violations, FATF has the power to place Russia on a “blacklist” that calls on FATF member countries to apply greater due diligence on financial transactions involving Russia. Russia’s placement on the FATF blacklist would, according to Minister Marchenko, “dramatically increase the cost of doing business with Russia.”

O’Toole noted that sanctions are only one aspect of the overall strategy to counter Kremlin aggression in Ukraine and beyond. “Ukraine’s victory relies on the bravery of the Ukrainian people and military supplies from the West,” he commented. At the same time, O’Toole stressed that sanctions “are a complementary policy” limiting the ability of Russia to fund its aggression.

Olena Halushka, co-founder of the International Center for Ukrainian Victory, compared Russian atrocities in Ukraine to the actions of “ISIS, Al Qaeda, or Hezbollah” and called on Western countries to label Russia a terrorist state. Halushka observed that Russia’s blacklisting by the FATF can also help “to close the loophole through which Western-made main components [including] microchips are ending up in Russian or Iranian weapons.” There will be no end to Russian aggression if there is no accountability, warned Halushka.

The global financial system is based on rules, commented Minister Marchenko. “We have powerful mechanisms to enforce these rules,” he noted. “The time has come to use them.”

Benton Coblentz is a program assistant at the Atlantic Council’s Eurasia Center.

Further reading

UkraineAlert Jan 28, 2023

Poland is leading Europe’s response to the Russian invasion of Ukraine

By Diane Francis

Poland was the unsung hero of the recent landmark decision by Berlin and Washington to provide Ukraine with tanks as Polish leadership continues to shape the European response to Russia’s genocidal invasion.

Conflict Economic Sanctions

UkraineAlert Feb 6, 2023

Hero Ukrainian medic: “Russia will not stop until it is stopped”

By Peter Dickinson

Ukrainian military medic Yulia Paievska has a simple message for anyone who still believes in the possibility of a compromise peace with Putin’s Russia. “They will not stop until they are stopped,” she says.

Civil Society Conflict

UkraineAlert Feb 1, 2023

Europe’s last empire: Putin’s Ukraine war exposes Russia’s imperial identity

By Botakoz Kassymbekova

Vladimir Putin’s genocidal invasion of Ukraine has exposed modern Russia’s unapologetically imperial identity but could yet lead to the collapse of the Kremlin’s broader imperial ambitions, writes Botakoz Kassymbekova.

Belarus Central Asia

The views expressed in UkraineAlert are solely those of the authors and do not necessarily reflect the views of the Atlantic Council, its staff, or its supporters.

Read more from UkraineAlert

UkraineAlert is a comprehensive online publication that provides regular news and analysis on developments in Ukraine’s politics, economy, civil society, and culture.

The Eurasia Center’s mission is to enhance transatlantic cooperation in promoting stability, democratic values and prosperity in Eurasia, from Eastern Europe and Turkey in the West to the Caucasus, Russia and Central Asia in the East.

Learn more

The post Countering Russian threats to global financial security appeared first on Atlantic Council.

How grave is Britain’s stagnation?

As Britain faces a historical rupture from its historical trend with flatlining productivity growth, Ben Judah spoke with Professor Adam Tooze, Director of the European Institute and Kathryn and Shelby Cullom Davis Professor of History at Columbia University on how this crisis looks from a historical perspective.

Why does the economic data suggest this is more serious than previous moments of feared decline? How does this stagnation compare to previous instances in the 1930s and 1970s? What impact has Brexit had on this trend? Would a Labour government under Keir Starmer be able to turn this around?

You can watch #BritainDebrief on YouTube and as a podcast on Apple Podcasts and Spotify.

Fellow

Ben Judah

Director

Europe Center Transform Europe Initiative

Economy & Business European Union

Europe Center

Providing expertise and building communities to promote transatlantic leadership and a strong Europe in turbulent times.

The Europe Center promotes the transatlantic leadership and strategies required to ensure a strong Europe.

Explore the program

The post #BritainDebrief – How grave is Britain’s stagnation? | A debrief from Dr. Adam Tooze appeared first on Atlantic Council.

How does the Western price cap on oil work?

As the G7 and European Union implement their new restrictions on Russian oil and gas exports, Ben Judah spoke with Eddie Fishman, Senior Policy Scholar at the Center on Global Energy Policy at Columbia University and nonresident senior fellow at the Atlantic Council’s Eurasia Center, to discuss the price cap.

Has the price cap already had an impact on Russian oil exports at this early stage? Is the price cap a new tool of economic statecraft? And can the price cap be used in a way to accelerate ongoing efforts to improve renewable energy infrastructure?

You can watch #BritainDebrief on YouTube and as a podcast on Apple Podcasts and Spotify.

Fellow

Ben Judah

Director

Europe Center Transform Europe Initiative

Economy & Business European Union

Fellow

Edward Fishman

Nonresident Senior Fellow

Eurasia Center

Russia Economic Sanctions

Europe Center

Providing expertise and building communities to promote transatlantic leadership and a strong Europe in turbulent times.

The Europe Center promotes the transatlantic leadership and strategies required to ensure a strong Europe.

Explore the program

The post #BritainDebrief – How does the Western price cap on oil work? | A Debrief from Eddie Fishman appeared first on Atlantic Council.

Beyond Russia, Chevron recently made the first shipment of Venezuelan oil to Texas, while the White House is likely to announce an executive order on outbound investment screening after Secretary of State Antony Blinken’s visit to China in February. 

Russia’s draining budget

Western capitals imposed sanctions to run the Russian economy to the ground. But sanctions’ initial effects fell short of expectations. The ruble, rather than being reduced to rubble, reversed its initial depreciation and even became the best performing currency of 2022. It is misguided to use exchange rates as the main indicator of an economy’s health. However, the ruble’s good health tells us something about the relative value of Russia’s imports and exports, and the record-breaking balance of payments surpluses of Q2 and Q3 last year.

Even with high energy prices and additional income, Russia’s surging budget deficit shows that the invasion is causing Russia to spend much more than it is making in revenue. The Russian budget had a deficit of forty-seven billion dollars in 2022, one of the highest since the breakup of the Soviet Union. Although the Russian government conveniently decided not to publish data on the government spending this year, it is safe to assume that military spending contributed to the bulk of the increase in spending. 

Going into 2023, Russia’s budget deficit may be higher than Russia claims. Moscow anticipates its budget deficit in 2023 to be 2 percent of gross domestic product (GDP), based on the assumption that Russia’s flagship crude blend Urals is traded at seventy dollars a barrel. However, if the oil price cap lowers the Russian oil price to the maximum of sixty dollars while spending remains the same, the deficit would be closer to 4.5 percent, according to Financial Times estimates. 

To keep filling in the budget deficit and financing the war in Ukraine, Moscow will have to redirect funds from other domestic programs. In 2022, additional budget revenue came from Russia’s sovereign wealth fund, the one-time taxing of Gazprom, and issuance of largest-ever Federal Loan Obligations. However, in 2023, as the European Union (EU) works hard to diversify away from Russian gas, Gazprom is likely to have less revenue, therefore less tax revenue. Meanwhile, diverting sovereign wealth fund money toward the war takes away Russia’s rainy day fund and might result in slashing funding for schools and hospitals next year. 

Oil price caps: Working for now, likely to face challenges

The price cap on seaborne Russian crude oil came into effect on December 5, 2022. It stipulates that unless buyers can prove that they have paid below sixty dollars for Russian oil, they will be denied Western maritime services, such as insurance and brokerage. The Russian flagship crude blend Urals price has not reached sixty dollars since December. Even Russian government officials admit that freight costs for Russian oil have increased. 

Russia cannot afford to follow through on the promise of blocking sales to countries complying with the oil price cap, but it will attempt to undermine the cap. Since the policy came into effect, at least seven Russian oil tankers with Western insurance have left from Russia’s Baltic ports for Indian refineries. These tankers would not be able to insure their cargo if they were selling above sixty dollars. Some assert that the price cap will continue to work because sixty dollars is an acceptable price for Russia. However, we should not reach premature conclusions as Russia will be actively looking for options to sell above the capped price. One of the options in the short term is for Russia to self-insure and use Indian or Chinese vessels not subject to US or EU jurisdictions, and build up a fleet of crude vessels in the longer term. 

Despite even more daunting enforcement challenges, Group of Seven (G7) partners will expand the price cap to Russian refined petroleum products, such as diesel and kerosene on February 5. Sanctioning Russia’s fuel exports is likely to cause the rerouting of Russian diesel to India from the EU. But the EU still needs diesel supplies and it will be purchasing them from the United States and India. Thus, Russian diesel supplies may travel a lot more before finally reaching the EU again, creating inefficiencies in the market. However, the EU is prepared to take this step while it is simultaneously banning almost all imports of Russian oil products. 

New year, new deal: Resumption of Venezuela oil exports to the US

Since Russia’s invasion of Ukraine started in 2022, the United States and EU have been looking for alternative oil suppliers. This presented an opportunity to Venezuela—a heavily sanctioned country which happens to have the world’s largest oil reserves—to fill in the oil gap created by the sanctions against Russia. President Nicolas Maduro’s domestic political concession—resuming negotiations with the opposition party—has won him the issuance of General License 41 by the Treasury Department. The six-month license allows Chevron Corporation to resume natural resource extraction in Venezuela. In January, Chevron delivered its first oil shipment of half-million barrels of oil to the refineries in Texas. 

The resumption of Venezuelan oil shipments to the United States is a temporary alignment of interests for both parties. The United States is trying to fill in the vacuum created in the world energy markets by banning Russian oil. Meanwhile, as oil export finances two-thirds of Venezuela’s budget, Maduro is capitalizing on the opportunity of reviving Venezuela’s dilapidated oil industry and bringing in much-needed revenue for his government.

However, the United States is treading carefully, as it should. The license is only for six months, and sanctions can be reimposed at any time within that period should Maduro appear to violate human rights or end dialogue with the opposition.

China may become the testing ground for another US economic statecraft tool: outbound investment screening

In contrast with Venezuela, US-China relations have only been on the downhill since last year. In addition to the tech export controls we discussed in the previous edition, the United States has recently issued sanctions on over 150 Chinese illegal fishing ships. Notably, for the first time, the Treasury sanctioned a Chinese company listed on a US stock exchange, Pingtan Marine Enterprise. But that’s not all. 

The United States is considering screening outbound investment to China, to ensure that US companies aren’t transferring technology and know-how to Chinese military-civil fusion companies. In the United States, an executive order on outbound investment in China is likely to come out after Blinken’s visit to China in February, which is expected to be followed by legislative action later. The US Senate is actively engaging with experts to examine outbound investment screening. Explore our joint publication with the Center for a New American Security to find out how such a mechanism should be designed. 

Meanwhile, in the EU, Germany is pushing for the creation of an EU outbound investment screening mechanism. The European Commission already included this issue in the 2023 agenda. However, at first, screening would happen on a small scale so the EU authorities would have a chance to observe the consequences. With close collaboration among the EU member states and both sides of the Atlantic, outbound investment screening has the potential of limiting the technology transfer to Chinese military-civilian companies.

Global Sanctions Dashboard

The Global Sanctions Dashboard provides a global overview of various sanctions regimes and lists. Each month you will find an update on the most recent listings and delistings and insights into the motivations behind them.

Explore Here

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Global Sanctions Dashboard: How sanctions will further squeeze the Russian economy in 2023 appeared first on Atlantic Council.

A hidden web of power revealed itself to Internet users in early 2022. Following a brutal government crackdown in Kazakhstan in January, anyone using open-source flight-tracking websites could watch kleptocratic elites flee the country on private jets.

A little more than a month later, Russia’s invasion of Ukraine brought a new spectacle: social media users were able to track various oligarchs’ superyachts as they jumped from port to port to evade Western sanctions. These feeds captured a national security problem in near real time: In Eurasia and beyond, kleptocratic elites with deep ties to the West were able to move themselves and their assets freely despite a host of speeches by senior officials, sanctions, and structures designed to stop them.

Kleptocratic regimes—kleptocracy means “rule by thieves”—have exploited the lax and uneven regulatory environments of the global financial system to hide their ill-gotten gains and interfere in politics abroad, especially in the United States, the United Kingdom, and the European Union. They are aided in this task by a large cast of professional enablers within these jurisdictions. The stronger these forces get, the more they erode the principles of democracy and the rule of law. Furthermore, the international sanctions regime imposed on Russia in response to its invasion of Ukraine has little hope of long-term success if the global financial system itself continues to weaken.

The West still has a long way to go to rein in the authoritarian kleptocrats who have thrived on the institutional dysfunction, regulatory failure, and bureaucratic weakness of the transatlantic community for far too long. We need to rethink not just how we combat kleptocracy, but also how we define it. Policy makers need to understand that authoritarian regimes that threaten transatlantic security are closely linked to illicit financial systems. As it stands, our thinking about how foreign corruption spreads is too constrained by stereotypes about kleptocratic goals and actions.

Outdated mental images of kleptocracy hobble the West’s response

Most transatlantic policy makers have in mind the first wave of kleptocracy, which primarily flourished in the late twentieth century. Its rise was intertwined with that of transatlantic offshore finance, which prompted a race to the bottom in financial regulation and a rise in baroque forms of corruption across the post-independence “Third World.”

The corrupt autocrats of the Cold War era flaunted the wealth they stole from their own people. These kleptocrats, many of whom are still spending large today, usually did not weaponize their corruption to influence the foreign policies of the United States or its allies. They were content to offshore their ill-gotten gains in US, UK, and EU jurisdictions with lax oversight over these types of transactions.

But this mental image of the kleptocrat is outdated: These kinds of kleptocratic leaders are not extinct, but they are curtailed. It is no longer a simple matter for first-wave kleptocrats to access the global financial system. Many of the regulatory loopholes exploited by these classic kleptocrats have either already been addressed or are in the process of being closed.

The second wave of kleptocracy, which emerged since the 2000s, is more sophisticated, authoritarian, and integrated into the global financial system than its predecessor. Second-wave kleptocrats intend to use the global financial system for strategic gains—either for self-gain and/or to reshape it in their image—instead of just hiding or securing the money they have stolen. Most notably, this evolution accelerated in Russia under President Vladimir Putin before February 2022, with the agendas of oligarchs and kleptocrats being subordinated to and intertwined with the plans of an ambitious state authoritarian.

Alongside this weaponized corruption, there has arisen in the West a coterie of enablers among the policy makers targeted by second-wave kleptocrats.

The second wave of kleptocracy is more sophisticated, more authoritarian—and more dangerous

Though our understanding of the threat posed by illicit finance has grown ever more sophisticated, our conception of a kleptocrat remains frozen in the mid-to-late 2000s: halfway between David Cronenberg’s 2007 London Russian gangster movie Eastern Promises, which depicted ties between the Russian state and overseas mafia groups, and the 2011 case of Teodoro Nguema Obiang Mangue, vice president of Equatorial Guinea, in which the US Justice Department seized a Gulfstream jet, yachts, cars, and Michael Jackson memorabilia. Both depictions—one fictional, one real—describe the world of ten years ago, when the second wave of kleptocracy was still relatively new.

So what does kleptocracy look like today?

The natural resources tycoon

The tycoon is a figure who has “assimilated” into the global financial system and been recognized as a legitimate businessperson because they provide a consistent source of fossil fuels to the United States and its allies. They view the transatlantic world above all as a market, but they cannot deviate too far from loyalty to the regime in the country from which they extract natural resources. As a result, the kleptocrat as natural resources tycoon has a strongly supportive relationship with the regime, which turns a blind eye to their criminal techniques. These tycoons often “donate” parts of their revenue to leadership figures. Several Russian oligarchs would seem to fit this typology, such as Gennady Timchenko, if many of the allegations against him are true.

The private corporation subordinated to authoritarian objectives

Private corporations can be a vector for state-sponsored weaponized corruption, especially if the state is controlled by a one-party authoritarian regime at odds with the United States, its allies, and the liberal international order. US officials remain suspicious of one private corporation’s connections to the Chinese Communist Party. Even though the corporation is officially privately owned, 98.99 percent of this corporation’s stock is officially owned by a trade union committee representing employees (with the remainder held by the corporation’s founder). However, all trade unions in China are required to be part of a CCP-run labor federation. A British parliamentary inquiry into the potential security risks of Chinese technology companies noted that, even if they were not directly led by the CCP, they tended to maintain very strong links, including receiving billions of dollars’ worth of funding from the Chinese government.

The Western enablers

A respected mainstream democratic politician was the leader of a major bloc in the Parliamentary Assembly of the Council of Europe (PACE). In this capacity, he led other PACE members to vote down a resolution based on a 2013 Council of Europe report that condemned Azerbaijan’s human rights record. However, it was later revealed that the enabler’s actions had been influenced by extravagant bribes from Ilham Aliyev’s regime in Azerbaijan.

These cases of second-wave kleptocracy show why, despite a decade of transatlantic anti-corruption activism and the sanctions imposed on the Kremlin’s cronies and war chest, the kleptocrats are still winning even as their objectives have evolved.

Chronically underregulated industries fuel the problem

As regulations have caught up to the first wave of kleptocracy, foreign kleptocrats are increasingly switching to different channels for illicit finance. 

Central to both the failure of transatlantic regulation and the strategies of second-wave kleptocrats are chronically underregulated financial industries: private investment firms, art dealerships, real estate agents, and luxury goods providers. The global arts trade industry was estimated to be worth $65 billion in 2021, with the United States, the UK, and the EU accounting for at least 70 percent ($45.5 billion) of worldwide sales.

As of 2020, the total value of assets under management in the global private investment industry was estimated at $115 trillion, more than $89 trillion of which was in the US, UK, and EU.

In 2020, the global value of residential real estate was an estimated $258.5 trillion, with North America and Europe together composing at least 43 percent of that value (approximately $111.155 trillion).

The cryptocurrency market is the newest. It is also less stable than other financial industries, so its relative size and value fluctuates more dramatically.

Weaponized corruption in action

The 1Malaysia Development Berhad (1MDB) scandal was the largest political scandal in Malaysian history and the most publicly known case of kleptocracy in the world before the release of the Panama Papers in 2016.

Photos: Reuters

A large amount of the stolen wealth remains in US real estate and fine art, which the Department of Justice is continuing to recover on behalf of Malaysia. As of August 2021, more than $1.2 billion had been recovered. Yet, given the number of private investment firms, real estate traders, film producers, and arts dealers that were involved in the 1MDB-related illicit finance, it is highly likely the stolen funds have been dispersed across a variety of industries. With better financial intelligence sharing between US, UK, and Dutch authorities, these suspicious dark money flows might have been identified before the money was moved across US financial institutions.

What needs to happen to take on the second-wave kleptocrats?

The US, UK, and EU need a more structured relationship to develop anti-corruption policies. We propose a new mechanism for the transatlantic community to harmonize its necessary response: a Transatlantic Anti-Corruption Council to coordinate anti-corruption policies between the United States, the UK, and the EU. It could connect the various US, UK, and EU agencies and directorates that work on corruption and kleptocracy-related issues, and organize them into expert groups focused on illicit finance, tax evasion, acquisition of luxury goods, and more. Recent cases of weaponized corruption have exploited the lack of regulatory coordination and financial intelligence sharing between transatlantic jurisdictions to evade detection and to corrupt transatlantic democratic and financial institutions. The TACC can work on closing these gaps—but it is only the beginning of a larger transatlantic strategy against weaponized corruption.

The anti-corruption policy to-do list

United States

In the United States, much of the problem stems from a lack of legislation enabling more comprehensive law enforcement and regulatory compliance within these underregulated industries. The United States should:

• Follow through on the US legislative national anti-corruption strategy. Many of the existing flaws in the US regulatory sphere were correctly identified and should be addressed accordingly. This includes the strategy’s commitment to increasing regulation on the private investment industry, including on firms managing assets totaling less than $100 million.
• FinCEN, the US FIU, is chronically understaffed, underbudgeted, and relies on outdated technology. Even if legislative reform was passed and/or executive action taken to extend BSA/AML obligations to more financial institutions, FinCEN would be hard-pressed to fully investigate reports it received and to enforce its authority in cases in which financial crime was present.

United Kingdom

The UK, on the other hand, already has much of the legislation it needs to address anti-money-laundering (AML) deficiencies and sanctions evasion occurring in its jurisdictions. It needs to implement that legislation—and address the close connections between the City of London and British Overseas Territories and Crown Dependencies. The UK should:

• Share legalistic principles and good practices of unexplained wealth orders (UWOs) with allies. UWOs have already proven to be very effective in bringing more investigative power to bear on to foreign kleptocrats based in the United Kingdom
• Reduce regulatory mismatches between the primary UK jurisdictions and the Crown Dependencies and Overseas Territories, especially with beneficial ownership registries and sanctions compliance
• Improve verification standards for companies registered in Companies House to identify shell companies
• Fully implement and enforce existing transparency and national security laws, especially the National Security and Investment Act

European Union

Much like the UK, many of the EU’s problems stem less from a lack of legislation than from the implementation of those policies. The EU faces additional hurdles in ensuring that all its member states harmonize their AML policies. The EU should:

• Increase compliance requirements for private investment firms managing assets totaling less than €100 million
• Fully implement the 6th Anti-Money Laundering Directive (6AMLD) across EU jurisdictions. The establishment of an EU Anti-Money Laundering Authority will be essential for harmonizing regulations across the European Union (EU).
• 6AMLD measures should also be applied to overseas autonomous territories like Aruba.
• Increase enforcement of laws that prohibit the spread of corruption in foreign territories, particularly for cases that involve spreading corruption to fellow EU member states

Transatlantic community

The transatlantic community should:

• Work closely with the United States in its national anti-corruption strategy. The strategy’s success will be heavily dependent on the degree of cooperation between US allies and the Biden administration in its implementation.
• Match regulatory legislation on both sides of the Atlantic. This will permit better coordination of sanctions between allies and reduce tensions between the United States and its allies when the United States relies on extraterritorial action.
• Create channels for financial intelligence units and private sector actors in transatlantic jurisdictions to share information about suspicious clients, transactions, and transfers. The Europol Financial Intelligence Public Private Partnership (EFIPPP) may be a good platform for increased intelligence sharing.
• Establish the Transatlantic Anti-Corruption Council (TACC). Its main purpose would be to coordinate legislation on improving anti-money laundering/Know Your Customer (AML/KYC) policies, share good governance policies (such as beneficial ownership registries) to harmonize regulations, crack down on sanctions evasion, and share financial intelligence on transnational financial criminals to shut down their operations.
• The TACC should also regularly convene expert working groups on, at a minimum:
• trade-based illicit finance,
• market-based illicit finance,
• bribery and other enabling forms of corruption,
• acquisition of luxury goods by kleptocrats,
• asset returns,
• tax evasion,
• terrorist financing, and
• future threats.
• Financial intelligence working groups should similarly cover individual cases of financial crime at the tactical level. At the executive level, primary stakeholders in the TACC should be
• the Departments of State, Treasury, and Justice, and USAID on the US side,
• the Foreign, Commonwealth & Development Office (FCDO); His Majesty’s Treasury; and the Home Office on the UK side, and
• the Directorate-General for Economic and Financial Affairs; Directorate-General for Financial Stability, Financial Services and Capital Markets Union; and Directorate-General for Justice and Consumers on the EU side

The late United Nations secretary-general Kofi Annan once said: “If corruption is a disease, transparency is a central part of its treatment.” Annan spoke in a time before the crisis of weaponized corruption rose to prominence, but his words ring clearer now that foreign kleptocrats are spreading their malign influence by means of the money they stole from their own people. The United States and its allies must choose the partners with which it engages more carefully. Otherwise, it may find that some of its partners are in fact proxies for strategic competitors of the transatlantic community who will undermine the West’s security and the integrity of its democracies from the inside.

Related content

New Atlanticist Nov 9, 2021

How to get Biden’s democracy summit right

By Daniel Fried, Rose Jackson

Two of the Council’s democracy experts say the upcoming Summit for Democracy needs to take aim at autocrats’ tools by focusing on anti-corruption and tech standards, and elevating civil society.

Civil Society Corruption

New Atlanticist Apr 5, 2022

How the world’s parliaments can team up against Russian aggression

By Francis Shin and Riho Terras

An interparliamentary alliance against Kremlin aggression would maximize global efforts to coordinate sanctions and keep the pressure on Moscow.

Corruption Economic Sanctions

UkraineAlert Oct 26, 2022

The West needs a more united approach to sanctioning Putin’s elite

By David Clark

With Russia’s invasion of Ukraine now in its ninth month, it is time for a coordinated approach to sanctioning Putin’s elite that reflects the seriousness of the threat they pose to global security, writes David Clark.

Conflict Corruption

The post Authoritarian kleptocrats are thriving on the West’s failures. Can they be stopped? appeared first on Atlantic Council.

The post Crypto Regulation Tracker cited by The Hill in an opinion piece on ‘The Six Principles for Governing Crypto Regulation.’ appeared first on Atlantic Council.

As this year began, many experts predicted inflation would be transitory, Europe’s recovery would be stronger than the United States’, and China would return to strong growth. Then inflation soared and Russian President Vladimir Putin invaded Ukraine—fueling an energy crisis in Europe and food price shocks around the world. Meanwhile, China’s zero-COVID policy chained its economy. To make sense of a shocking year for the global economy, our GeoEconomics Center experts take you inside the numbers that mattered—including many you may have missed—in 2022.

Over the past year, the market value of cryptocurrency assets has collapsed from $3 trillion to about $850 billion as Bitcoin—the original and best-known cryptocurrency—plunged from $68,000 to $17,700, stablecoins such as TerraUSD broke the advertised one-to-one peg to the US dollar, and the crypto-exchange FTX sank from a $32 billion valuation to bankruptcy within a week. Those losses and market turmoil have laid bare the volatility of crypto-assets and the pressing need for consumer protections. 

Going forward, crypto-assets may not recover their full value, and it’s clear that regulation needs to be tightened to deal with the financial instability and lack of consumer protections exhibited by this year’s market upheaval. In our latest tracker, the GeoEconomics Center explored regulatory developments in twenty-five jurisdictions, which include Group of Twenty (G20) member countries and six countries with the highest crypto adoption rates. Among the countries we studied, cryptocurrency is legal in thirteen, partially banned in nine, and generally banned in three. We found that in 88 percent of the countries we studied, crypto regulations were under consideration, and the next frontier of regulatory developments will be on stablecoins. The United States has a number of legislative proposals under consideration currently, with a larger debate on which regulatory authority must have jurisdiction over crypto-assets. Watch for 2023 to be a marquee year on crypto regulation, especially as Europe and the United Kingdom clarify their regulatory structures.

—Ananya Kumar is the associate director for digital currency at the GeoEconomics Center. 

A striking ten of the G20 countries (including Russia of course) do not participate at all in the financial sanctions triggered by the invasion of Ukraine.

Admittedly this division did not prevent the issuance of a G20 Bali Leaders’ Declaration on November 16 stating: “Most members strongly condemned the war in Ukraine and stressed it is causing immense human suffering and exacerbating existing fragilities in the global economy—constraining growth, increasing inflation, disrupting supply chains, heightening energy and food insecurity, and elevating financial stability risks.”

Yet only advanced economies have joined the sanctioning process, even if to a varying extent, whereas emerging economies (except for South Korea) are not involved. This illustrates how fragmented the world has become and contrasts with the G20 momentum created by the global financial crisis—during which the entire group was largely on the same page in crafting a robust response.

—Marc-Olivier Strauss-Kahn is a nonresident senior fellow at the GeoEconomics Center and a former director general and chief economist for the Banque de France.

In October, a US government report found that the Russian military lost six thousand pieces of equipment since invading Ukraine in February. The imposition of Western sanctions has made it difficult for Russia to acquire the supplies and foreign parts it needs to repair or maintain this lost equipment, which includes items such as tanks, armored personnel carriers, and infantry fighting vehicles. This six thousand figure is important because it offers a tangible example of how sanctions can undermine a country’s war machine and make it difficult to pursue its aggression. Now, because of sanctions, the Russian regime must find other costly and more complicated means of acquiring hard-to-find parts, which was a deliberate goal of the sanctions, as reported by the New York Times. Often, when analysts, the press, or even governments discuss the impact of Russia sanctions, they first look at the state of the Russian economy or currency. But those figures are not entirely affected by sanctions and can change for numerous reasons; whereas, this six thousand figure is proof that sanctions are working to achieve their stated goal—to undermine Russia’s aggression against Ukraine.

—Hagar Chemali is a nonresident senior fellow at the GeoEconomics Center and a former spokesperson for terrorism and financial intelligence at the US Treasury Department.

This is the amount of Central Bank of Russia (CBR) reserves that Group of Seven (G7) nations and the European Union (EU) have immobilized since Russia’s invasion of Ukraine. In response, CBR Governor Elvira Nabiullina pledged to file legal claims in order to recover the reserves, but she has yet to set a timeframe to do so. Meanwhile, experts and policymakers on both sides of the Atlantic have discussed seizing frozen Russian reserves and using them for Ukraine’s reconstruction. However, this effort is hindered by laws in the EU and other sanctions-wielding countries. Confiscating frozen assets is allowed only in case of criminal conviction, and even then, getting each case through the court could take years.

But even before it could seize the frozen assets, the West still has to identify where the blocked assets are. Sanctioning jurisdictions are publishing reports at their own pace on how much Russian reserves they have immobilized, but a multilateral effort is essential to identify the rest. We are hearing that the US government is certain about the location of only a third of the three hundred billion dollars, and it is working to find the rest.

Sanctioning the CBR and blocking its assets held in Western central banks took Moscow by surprise. However, the policy hasn’t delivered the punch to the gut that it might have. At least not yet. The West has options now to make it truly hurt.

—Maia Nikoladze is a program assistant at the Economic Statecraft Initiative within the GeoEconomics Center.

On December 5, the G7-led price cap on Russian oil exports came into force. The decision to place the initial cap at sixty US dollars per barrel was reached only a few short days beforehand. EU member states that had pushed for a much lower cap managed to secure a last-minute drop from sixty-five.

Wary of adding more complexity to an already tense market, the policy’s original backers in the US Treasury are reasonably happy with a cap that is close to the average price Russia has been selling at over the past six months. In their view, this locks in a discounted price, which has already cost Moscow billions in lost revenue and which new buyers of Russian oil such as India will unashamedly use as they negotiate contracts.

Implementation relies on Western providers of insurance and shipping services, which must ask buyers of Russian oil for attestations that they have paid at or below the cap. So far, energy markets seem to understand the guidance that has been issued and we haven’t seen any major price swings. This doesn’t rule out snags that could fuel fears over supply, such as the recent situation where Turkish authorities started demanding proof of insurance from all tankers flowing through the Bosphorus.

—Charles Lichfield is the deputy director of the GeoEconomics Center.

This year produced one of the most significant sanctions programs ever devised, both in terms of the scale of the economy where sanctions were imposed, as well as the speed and comprehensiveness of the tactics used. Despite the fact that Western sanctions programs expanded by 42 percent in 2022, there are still substantial sectors where Russia trade continues and has grown in some instances. The one absent element of an effective sanctions program has been enforcement—which has been severely lacking in the United States, United Kingdom, and EU against violators of the Russia sanctions. There has yet to ever be an EU sanctions enforcement action, and some nations don’t even have the legal authority to levy sanctions. Enforcement in the United States, which historically has led the world in monetary fines, has dropped substantially in each of the past three years. While cases typically take time to build, early moves to highlight and penalize sanctions violators could serve the objective of continuing to put on notice those that would try to still carry out certain business with Russia.

—Daniel Tannebaum is a nonresident senior fellow in the GeoEconomic Center’s Economic Statecraft Initiative and a partner in Oliver Wyman’s Risk and Public Policy Practice, where he leads the firm’s Global Anti-Financial Crime Practice.

Sixty countries globally have reached an advanced stage of central bank digital currency (CBDC) development. As of November, the United States is one of them. 

Eighteen of the G20 countries have CBDCs under development, piloted, or fully launched, as reported in our Central Bank Digital Currency tracker. Motivations differ globally for CBDC exploration, from concerns about international standards setting to efforts at improving financial inclusion. The logistical difficulties of sending physical COVID-19 stimulus checks called attention to inefficiencies in US payment systems. By harnessing technology, including the blockchain, central banks may be able to develop payment systems that are quicker, cheaper, and safer. In November, the New York Federal Reserve released a white paper explaining that it was starting to test a wholesale (bank-to-bank) CBDC in cooperation with the Monetary Authority of Singapore. In doing so, it joined the European Central Bank, which is already in the development stages for a retail digital euro. A pilot program for China’s digital currency, the e-CNY, began in 2020 and has now expanded to over two hundred million users.

With the risks of cryptocurrencies and stablecoins front and center in the news, attention may turn more and more to central banks. CBDC development, and what the United States does next, will play a major role in the future of payments in 2023.

—Sophia Busch is a program assistant at the GeoEconomics Center.

The Biden administration has declared US dependence on advanced semiconductors produced in Taiwan as “untenable and unsafe” (in the words of Commerce Secretary Gina Raimondo) because of the threat to the country from neighboring China. As a result, the administration in 2022 prioritized the passage of the CHIPS and Science Act, which was signed into law in August. The law provides fifty-two billion dollars of subsidies and tax incentives to promote the development of cutting-edge semiconductor factories on US soil. One of the projects taking advantage of that funding is being undertaken by Taiwan Semiconductor Manufacturing Corporation (TSMC), which currently produces over 90 percent of the most sophisticated chips in the world in Taiwan. When TSMC’s Phoenix plant reaches full capacity in the next two years, it will produce about twenty thousand wafers of semiconductors each month. That will only represent less than 1.6 percent of the company’s current monthly output of 1.3 million wafers. Reducing dependence on Taiwan will remain a long way off.

—Jeremy Mark is a nonresident senior fellow at the GeoEconomics Center and former official at the International Monetary Fund (IMF) and reporter for the Wall Street Journal.

Investment screening regulations continued to proliferate, strengthen, and expand in 2022. Seven EU member states drafted, introduced, or started consultation processes for new investment screening authorities this year (Belgium, Croatia, Estonia, Greece, Ireland, Luxembourg, and Sweden). In the United States, the Biden administration issued the first executive order designed to provide clarity over the process by which the Committee on Foreign Investment in the United States (CFIUS) evaluates the national-security implications of foreign acquisitions of US businesses. And this fall saw two congressional hearings on the prospects of creating a CFIUS-like process for outbound investment. Look out for increased regulation over both inbound and outbound investment among major economies in 2023.

—Sarah Bauerle-Danzman is a nonresident senior fellow with the GeoEconomic Center’s Economic Statecraft Initiative and associate professor of international studies at Indiana University.

North America is still the commercial dynamo for the United States, with over three million dollars per minute in goods traded between the United States and its two neighbors through September of this year.

Canada and Mexico are the top two US trade partners, together accounting for more than twice what the United States trades with China. North American trade is growing at double digits within the framework of the US-Mexico-Canada agreement (USMCA), which came into effect in 2020.

In the most recent study available, North American trade was estimated to support more than twelve million US jobs in 2019 and millions more in Mexico and Canada.

North America is demonstrating the clear potential to emerge more competitive globally vis-a-vis China and other commercial powerhouses, as the world transforms following the pandemic, the war in Ukraine, and other disruptions. The question will be how well the United States, Canada, and Mexico can work through differences and seize the opportunities to maintain the impressive commercial growth that can boost the continent’s prosperity and well-being.

—Earl Anthony Wayne is a nonresident senior fellow at the GeoEconomics Center and a former US ambassador to Mexico.

A staggering and concerning 60 percent of low-income countries are currently at risk of debt distress or debt default, according to the IMF. If a series of low-income countries were set to default, it is possible the IMF would not have enough resources to to disburse the loans these countries would need to keep afloat. The G20 had a plan to deal with the problem called “the common framework.” It was supposed to be a way to help countries restructure their debt and involve the world’s largest bilateral creditor, China. But only a handful of countries have used the system—largely because it’s slow and private creditors haven’t fully signed on. This number is a flashing red light for the global economy headed into 2023. 

—Josh Lipsky is the senior director of the GeoEconomics Center.

Forty-five million people are expected to face starvation by the end of 2022. A series of economic shocks sent global food prices to an all-time high in 2022 and curbed households’ ability to pay for sustenance. Extreme global uncertainty and the prospect of sudden unemployment resulted in food hoarding in 2020 during the pandemic. The supply-chain constraints of 2021 then dramatically increased transport costs for those items. And Russia’s invasion of Ukraine at the beginning of 2022 unexpectedly eliminated large volumes of food items from the global market overnight. In the past year, food insecurity was exacerbated by export bans by other major grain producers, weakening currencies, and accelerating inflation around the world. The threat of a global recession next year now looms large over hundreds of millions of people who are struggling to fulfill basic human needs.

—Mrugank Bhusari is a program assistant at the GeoEconomics Center.

In November, the world’s population surpassed eight billion and is expected to continue to rise as life expectancy increases around the world and fertility rates remain high in several regions, primarily sub-Saharan Africa and South Asia. The geoeconomic and development implications are stark and are compounded by the lingering effects of COVID-19 as well as climate change and conflict. The world’s people and resources are not distributed equally, and inequality within and among countries is rising. Ever-expanding cities seek to capitalize on the benefits of agglomeration while managing the resulting stress on infrastructure and services. At the same time, in lower- and middle-income countries—which tend to be the most populous—food, health, and education systems struggle to meet expanding and evolving needs. 

Younger and older people tend to bear the brunt of the challenges associated with population growth, especially in terms of economic opportunity as job creation fails to keep pace with the number of labor market entrants, and digitization, automation, and the changing nature of work put worker longevity and job security at risk. However, history and emerging evidence show that strategic economic and environmental policies combined with investments in human capital, lifelong learning and wellbeing, and technologies that increase innovation and productivity are what enable the accumulation of earnings and intergenerational wealth. That catalyzes consumption and can harness larger populations toward demographic dividends and sustainable, inclusive growth.

—Nicole Goldin is a nonresident senior fellow at the GeoEconomics Center and global head of inclusive economic growth at Abt Associates.

To combat inflation, central banks representing nearly three-quarters of the global economy, measured by gross domestic product (GDP) weight, increased their benchmark interest rates in 2022. Most noticeably, this was done by the US Federal Reserve (the Fed), European Central Bank (ECB), and Bank of England, together accounting for 42 percent of global GDP. The Bank of Japan, People’s Bank of China, and Central Bank of the Republic of Turkey were among the few central banks cutting their benchmark interest rates in 2022. When it comes to central bank rate hikes, it is important to note that forty-one countries have their currencies pegged to the US dollar and/or euro. To protect the peg while also allowing for the free flow of capital, these economies have no choice but to increase their domestic interest rates on par with the Fed and ECB—even if domestic inflation is not a concern for their economies—therefore reducing their growth potentials. Oil and gas exporting countries of the Persian Gulf are among these economies.

—Amin Mohseni-Cheraghlou is the macroeconomist at the GeoEconomics Center and an economics professor at American University.

On September 28, 2022, the US dollar, euro, and British pound were closer to a triple parity than ever before. The dollar had appreciated against most currencies throughout the year, reflecting the relative strength of the US economy, the Federal Reserve’s determination to bring inflation down by sharply raising overnight interest rates, and a flight to safety after the start of the Ukraine war. European inflation has been more strongly tied to energy, and the ECB was therefore slower to embark on a tightening cycle, helping the dollar breach parity to the euro in August for the first time in twenty years. And in late September, the pound fell to the lowest ever value against the dollar after the short-lived government of Prime Minister Liz Truss presented its inflationary tax-cut proposals and the Bank of England had to prevent a collapse in the UK government bond market. Both the euro and pound have rebounded since, but for a short moment the three currencies were only a few basis points away from being valued equally.

—Martin Mühleisen is a nonresident senior fellow and former chief of staff and strategy director of the IMF.

The share of global environmental, social, and governance (ESG) investments as a proportion of total assets under management is projected to increase from 14.4 percent in 2021 to 21.5 percent in 2026.

ESG funds, which evaluate how well companies are managing risks and opportunities related to environmental, social, and governance issues, are growing rapidly to become the new default choice for investors. As investors refocus their long-term investment strategies, the demand for ESG funds is out-stripping the existing supply. Asset managers looking to deliver investor success and survive turbulent investment markets are embracing ESG funds as the best way to differentiate their products in the future. These emerging global trends in the asset and wealth management industry—led by the United States—provide a critical reality check on swiftly evolving investor priorities and an important counterweight to concerns that recent anti-ESG rhetoric and legislation were taking some of the steam out of enthusiasm for impact investing. ESG funds are the next big thing.

—John Forrer is a contributor to the GeoEconomics Center and director of the Institute of Corporate Responsibility at George Washington University

For most of the world, 2022 was the year the pandemic became endemic. While COVID-19 case numbers continue to soar, with year-over-year cases increasing by nearly 75 percent in 2022, deaths have sharply declined by some 67 percent when compared to 2021. At the same time, the pandemic remains one of the foundational trends shaping the global policy landscape—complicating a range of issues from Russia’s invasion of Ukraine to a potential global recession. In the United States, COVID continues to moderate economic productivity with a recent National Burea of Economic Research working paper estimating that people’s unwillingness to be in close proximity with others reduced labor force participation by 2.5 percent in the first half of 2022. This translates to roughly a $250 billion drop in potential output—or around 1 percent of GDP. COVID’s sweeping impact is most prominently playing out in China, which in recent weeks has been rocked by the most widespread protests in decades following nearly three years of periodic lockdowns and dampening economic prospects. 

—Niels Graham is an assistant director at the GeoEconomics Center.

The US Federal Reserve has reduced the size of its balance sheet in 2022 by $381 billion, draining liquidity from the financial system. This quantitative tightening (QT) policy aims to support the contractionary impact of the Fed’s interest-rate hikes to rein in inflation. At the current pace, the Fed will shed $1.6 trillion in assets by the end of 2023, reducing its overall balance sheet by roughly 18 percent. While it remains difficult to measure QT’s impact, a reduction of that size could tighten financial conditions significantly. This matters because it might allow the Fed to forego a rate hike in 2023 and/or start decreasing interest rates earlier. QT targets long-dated assets that have an outsized influence on equity and bond markets. A severe recession or the Fed’s desire to ease financial conditions could all spell an early end to QT. This is a space to watch in 2023.

—Ole Moehr is a senior fellow and consultant with the GeoEconomics Center.

That’s how many manufacturing jobs have been created in the United States since April 2020 (when manufacturing employment was at a record low) to reach a total of 12.9 million manufacturing jobs as of November 2022. US manufacturing employment started out at nine million in 1940 and rose steadily to a peak of 19.5 million in July 1979. The US then lost 8.1 million manufacturing jobs in the following four decades, a result of the hollowing out of the US manufacturing base due to the offshoring of manufacturing to other countries, in particular China. Since early 2020, pro-manufacturing policies in the US seem to have reversed the declining trend. It remains to be seen if this nascent recovery will be strengthened in the future as a result of efforts to attract high-tech manufacturing activity back to the United States with incentives provided to companies in the US CHIPS and Science Act and the Inflation Reduction Act.

—Hung Tran is a nonresident senior fellow at the GeoEconomics Center and a former IMF official.

Year to date, the US Commerce Department has designated 390 parties to the Entity List, a 260 percent increase over the designations made in 2021. Along with various other export-control mechanisms, Entity List designations are increasingly used to promote US national security and foreign-policy interests by restricting the target parties from receiving certain, or in some cases all, items subject to US regulation. Because US export controls are primarily property-based, these restrictions can be effective in covering gaps left by trade and economic sanctions, which may not apply to certain foreign parties whose dealings in US-regulated products, technologies, or software could benefit US adversaries. 

Unsurprisingly, the vast majority of Commerce’s Entity List designations in 2022 involved parties in Russia. Notably, parties elsewhere, including in certain US ally countries such as the United Kingdom and Spain, were listed for having acquired or attempted to acquire US-regulated products in support of Russia’s military, defense industrial base, or strategic ambitions. China was also heavily targeted by designations that took aim at parties involved in certain semiconductor manufacturing activities. Whether the swell in designations continues over time remains to be seen, but it seems likely that Commerce will continue to use the Entity List in furtherance of efforts to limit Russia’s and China’s military and advanced manufacturing capabilities. In addition, Commerce has the authority to designate parties whose host governments fail to facilitate US security-driven end-use verifications, as well as those involved in human rights, cybersecurity, and spyware-related threats. Regardless of the final numbers, the Entity List is a score worth tracking in 2023.

—Annie Froehlich is a nonresident senior fellow at the GeoEconomics Center’s Economic Statecraft Initiative and special counsel at Cooley LLP.

The post By the numbers: The global economy in 2022 appeared first on Atlantic Council.

The post Nooruddin in The Hindu: From a vicious cycle to a virtuous cycle appeared first on Atlantic Council.

In this edition of the Global Sanctions Dashboard, we walk you through the Fall sanctions against Russia and Iran, explain the implications of US semiconductor export controls against China, and show you the projected sanctions trends in 2023. 

New sanctions: Russia continues to be the top target

During the fall, sanctioning authorities around the world designated nearly 740 entities and individuals for their contributions to Russia’s unjust war against Ukraine. In response to Putin’s annexation of Luhansk, Donetsk, Kherson, and Zaporizhia, the United Kingdom imposed export bans targeting sectors that are highly reliant on Western goods and services. The new sanctions cut off Russia’s access to IT, engineering and other key services. The United Kingdom anticipates that these measures will halt Russia’s technological advancement. Targeting Russian industries that heavily rely on Western imports of goods or services has proved to be an effective policy, as multilateral export controls have resulted in the 70 percent reduction in semiconductor imports to Russia.

Like the United Kingdom, Canada also doesn’t show any signs of slowing down with Russia sanctions. It has sanctioned high-ranking government officials and frozen their assets. Notably, Canada has become the first country outside Ukraine to announce a rollout of a new Ukraine Sovereignty Bond. The proceeds of these Canadian government-backed five-year bonds will be channeled to Ukraine through the International Monetary Fund. Combining punitive measures against Russia with financial assistance to Ukraine will likely be a more effective policy than imposing sanctions and export controls alone. 

Beyond Russia, Western authorities have kept their eyes on Iran too, imposing 115 new sanctions. There were hopes that Iran would scale back its nuclear program in exchange for the United States lifting energy sanctions. However, due to Iran’s violent crackdown against ongoing anti-government protests, the Western authorities ratcheted up sanctions instead of scaling down. Sanctions on the Iranian officials could deter others from committing human rights violations, knowing that they would also lose access to US financial institutions. However, this will work only with individuals who have significant dealings with US financial institutions and unfortunately cannot solve Iran’s systemic discrimination against women. 

Will sanctioning Russia continue at the current pace in 2023?

As one of the most intense years for sanctions and economic statecraft observers draws to a close, we consider whether the current tempo of new sanctions will continue in 2023. Sanctions-wielding authorities around the world will be monitoring three key trends: 

Observing trends: Do sanctions pose a threat to the hegemony of the US dollar?

The slight fall in dollar reserves held worldwide has been noticed by economic statecraft observers. We would caution against a rash interpretation. Reserves are bought and sold by governments to support their currencies. In a year when the US dollar has gained 6 percent against emerging market currencies, it is almost surprising that holders of dollar-denominated reserves have not shed more. Clearly, oil exporters will have increased their holdings because they sell this lucrative commodity for the US dollar.

Our Senior Fellow Carla Norrlof in her original research for our Frankfurt Forum, showed that holdings in yuan have increased this year by 6.2 percent from a very low base. Reports of the death of the dollar hegemony are much exaggerated.

Tech export controls against China will barely cause an economic ripple in US

The United States recently invoked the powerful Foreign Direct Product Rule (FDPR) to restrict the exports of highly advanced semiconductors to China. The United States and its allies have a near monopoly on advanced semiconductor production, making export controls an effective tool for depriving countries such as Russia and China of the latest state-of-the-art chips. Unlike most sanctions and export controls that require compliance from US persons, FDPR obliges companies outside the United States to obtain a license before exporting high-end semiconductors to China if they used US software or hardware in the production process. FDPR’s implications are significant for China’s technological advancement because US software tends to be used by most semiconductor manufacturers around the world. 

Recent artificial intelligence export controls are the biggest escalation in coercive measures against China since the trade war. In 2020, the US Department of Commerce’s Bureau of Industry and Security added nearly three hundred entities to its Entity List–meaning US persons must obtain a license before exporting controlled items to those entities. But the recent FDPR goes beyond the United States. It aims to restrict the flow of all advanced semiconductors that could be used for military production and supercomputing. 

The restriction of state-of-the-art semiconductors is likely to have limited effects on overall US exports to China, which is also the case for Taiwanese exports to China. Semiconductors and related products consisted of around 9 percent of total US exports to China in 2021. Since the recent measure covers only highly advanced chips, a much smaller fraction of the total exports will be impacted. Notably, Semiconductor manufacturing equipment (SME) producing companies are likely to take the hit as their sales to China range from 13 to 30 percent of total sales. However, overall US chip exports to China won’t experience significant reductions. This is also the case for Taiwan, which exports 60 percent of its semiconductors to China but will abide by the US export controls, anticipating that only a small fraction of its chip exports will be affected. 

Sanctions projection in 2023

Numbers cannot tell us the whole story, but if Western countries imposed sanctions at the scale they did in 2022, we would reach more than 36,500 sanctions by the United States, United Kingdom, European Union, Switzerland, Canada, and Australia in the first quarter of 2023. This is mostly driven by Russia: as long as the war in Ukraine goes on, sanctioning will continue. Meanwhile in Iran, the prospect of reaching a nuclear deal is becoming weaker as the Iranian government engages in human rights violations and supplies Russia with drones. Against China, the United States might not choose financial sanctions as the main economic tool, but it will keep using export controls and most likely create a new authority for screening outbound investment to China.

Global Sanctions Dashboard

The Global Sanctions Dashboard provides a global overview of various sanctions regimes and lists. Each month you will find an update on the most recent listings and delistings and insights into the motivations behind them.

Explore Here

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Global Sanctions Dashboard: What’s coming in 2023? appeared first on Atlantic Council.

The post Cryptocurrency Regulation Tracker cited in Formiche appeared first on Atlantic Council.

The European Commission recently announced that it will reexamine the European Union’s (EU) export control regime to determine if additional tools are needed regarding outbound strategic investment controls. Whether or not the EU will follow through with new outbound investment controls, and what those might look like, may not be purely determined by European deliberations. It will also depend on the evolution of American national security policy and transatlantic diplomacy.

US legislation enabling the review of outbound investment from the United States towards adversarial countries like China and Russia may pass soon. If the National Critical Capabilities Defense Act (NCCDA) is passed, increased US outbound investment review will likely impact the transatlantic relationship. Although the EU-China Comprehensive Agreement on Investment (CAI) was shelved in early 2021, some EU constituents still want to expand their investment relationship with China. Their appetite may be undermined by the NCCDA. The United States and the EU therefore need to carefully work with each other as they develop outbound investment screening mechanisms to prevent transatlantic tensions and conflict.

Extending US-EU cooperation into this area will be challenging, but not impossible.

The United States is highly motivated, having grown increasingly wary about the CCP’s hold over Chinese “private” businesses and the civil-military fusion approach which obliges Chinese “civilian” companies to share their technologies with the military-security industrial complex. US lawmakers have indicated that they want “to have a multilateral approach with partners and allies to ensure that [the United States] help them foster their development and implementation of similar, complementary mechanisms.”

The outward investment review is intended to prevent US capital from flowing towards America’s strategic competitors’ defense and security relevant sectors. The concern is not only that Chinese companies garner US capital, but that capital flows are accompanied by significant technological and knowledge transfers. The review would focus on technology companies, but it might be expanded to encompass other sectors relevant to national security, which can involve everything from steel manufacturing to banking and financial services.

The EU Commission’s announcement that it will explore outbound investment screening, seems to follow upon the prospect of US legislation passing soon.

Ideally, the American and European screening regimes should be developed in joint consultation. Why? The multilateralization of outbound investment screening is logical merely from a technical perspective. American capital, knowledge, and sensitive technology may be tied up in European companies, which can still invest in China, independently from US regulators. US legislation, once extant, may even have extraterritorial reach, automatically affecting European investors in China.

Previous US investment screening legislation already gave US authorities the capability to intervene in Chinese-European deals. For example, in 2017, the German lamp maker Osram had to get approval from the Committee on Foreign Investment in the United States approval for the sale of a part of its business to a Chinese group. The 2020 Foreign Investment Risk Review Modernization Act can prevent European private equity and venture capital funds from investing in US technology companies if they are co-funded by Chinese investors.

From a more strategic perspective, the multilateralization of outbound investment reviews is also advantageous. The United States wants to deny its adversaries’ national security complexes access to capital, knowledge, and technology from both the United States and US allies and partners—including the EU.

While clearly necessary, a transatlantic conversation about reviewing outbound investments may also lead to lengthy and sometimes frustrating negotiations. European financial and commercial interests and American national security policy do not always overlap. For example, US efforts to limit European business interactions with Russia over Nord Stream 2, with Iran through secondary sanctions, and with China over, chip manufacturing have led to significant fall-out.

In this case, difficulties may emerge on at least three levels: the interests of European businesses, the absence of European “national security” standards, and diverging strategic concepts.

Regarding European business interests, in early 2020, the EU-China Comprehensive Agreement on Investment seemed likely to pass. The EU only shelved the deal after significant pressure from the incoming Biden Administration. However, German businesses invested more than ever in China in the first half of 2022. Voices in favor of reviving the EU-China investment agreement remain strong. Chancellor Scholz’ recent trip to Beijing, accompanied by a large business delegation, was a case in point.

The second difficulty is that there is no single European system for investment screening and the screening standards are not harmonized, although the EU Commission can issue non-binding “opinions.” What is considered security-relevant in one EU member state may be ignored in another. A foreign investment in a specific kind of technology may be off-limits in France, while Swedish or Bulgarian authorities may allow such an acquisition to proceed. There is a growing need for a joint European understanding about the nexus of economics and security. Addressing this need could be the way forward to harmonize the European approach to foreign investment screening, inbound and eventually outbound.

Third, at the most profound level, the United States and the EU will have to reconcile their visions of world order, strategic competition with China, and how the management of capital markets, including outward investments, relates to this broader vision. Washington and Brussels need to get this conceptual question right at the start to prevent tensions from arising later on.

Brussels therefore has two options. Either it will passively await new US legislation and American diplomatic pressure, which may subject European investors in China and beyond to American rules and perspectives. Doing so may create significant tensions and harm the transatlantic relationship. Alternatively, the European Commission and European member states proactively prepare their own views on the geopolitical and security implications of European and Western investments in adversarial states like China.

The Commission now seems to be pursuing the second, better option but has yet to translate its geopolitical perspective on capital markets into policy proposals. But it takes two to tango. The US and the EU should engage with each other to work on a common understanding and, ideally, a joint approach to outbound investment screening. The better their mutual understanding on these issues, the more likely the United States and Europe are to commit to a truly transatlantic approach to strategic competition with China.

Dr. Elmar Hellendoorn is a nonresident senior fellow with the GeoEconomics Center and the Europe Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

Econographics Aug 3, 2022

Trading geopolitics: The US-Chinese capital markets

By Elmar Hellendoorn

Increased Chinese-Western capital market integration is just one scenario. Instead, ”strong decoupling” or “muddling through” may prove more likely.

China Economy & Business

Blog Post Jan 28, 2022

China’s capital markets in the shadow of the CCP

By Elmar Hellendoorn

Under Chinese President Xi Jinping Chinese capital markers have become increasingly politicized as politics increasingly influence Chinese businesses. This politicization may have significant implications for those investing in Chinese financial assets.

China Economy & Business

Issue Brief Sep 14, 2022

Sand in the silicon: Designing an outbound investment controls mechanism

By Sarah Bauerle Danzman and Emily Kilcrease

The stakes for rethinking the investment relationship between the United States and China are high. An outbound investment mechanism must be narrowly targeted, clearly defined, non-duplicative of existing tools, scoped proportionately to administrative capacity, and paired with meaningful multilateral engagement with allies and partners. 

China Economy & Business

The post What US outbound investment screening means for Transatlantic relations appeared first on Atlantic Council.

This paper outlines reforms for Bretton Woods Institutions – such as the World Bank Group (WGB), the International Monetary Fund (IMF), and the World Trade Organization (WTO). The world needs a Bretton Woods 2.0 for the twenty-first century. The challenges that led to World War II — inequality, protectionism, and rising nationalism — have resurfaced and created the dire need for reform of these institutions.

New, even bigger challenges — such as climate change, pandemics, global inflation, and supply chain disruptions — now threaten the global economy and trade. The current institutions are too small and ill-equipped to adequately address the threats of widening wars and surging food and fuel prices. This paper argues that a new international financial and economic architecture is needed. Bretton Woods Institutions must be modernized and revamped to help address these problems for the remainder of the twenty-first century.

The new system requires three core “Rs” – a revised global remit, an enhanced resource base to help individual countries confront collective global problems, and the mandate to monitor agreed-upon global rules. The IMF must refocus itself on addressing global financial instability and macroeconomic policy. The World Bank must become a financial institution focused on planetary sustainability and shared prosperity. A strengthened WTO must become the forum for freer and fairer trade in goods, services, and cross-border transactions.

These institutions must work with regional and other United Nations (UN) specialized bodies. They should coordinate with bilateral aid agencies, sovereign wealth funds, pension funds, and private philanthropic organizations. The IMF, WTO, and WBG need to leverage their power and resources to draw in private capital at much higher levels. This would provide the Bretton Woods institutions with the needed resources and expertise to address rising global challenges and development needs. These reforms would create a stronger international economic and financial architecture suitable for the twenty-first century.

Related content

Report Oct 17, 2022

The evolution of the IMF: A case for IMF 1.5 before Bretton Woods 2.0

By Hung Tran

Bretton Woods Institutions will face enormous challenges going forward. While ambitious reforms are needed, its unlikely they will be seriously considered due to high geopolitical tension and mistrust among major countries. Nevertheless, the need for reform is pressing. Therefore, it is important to look at more feasible reform, narrower in scope and technocratic in nature, to improve the these institutions.

China Economy & Business

Report Oct 17, 2022

Changing Bretton Woods Institutions: How non-state and quasi-state actors can help drive the global development agenda

By Nisha Narayanan

This new report examines the increasingly influential role of non-state and quasi-public actors in global development and sustainable finance, specifically through the rising level of sustainable investments in emerging and development markets.

Economy & Business Fiscal and Structural Reform

Report Oct 17, 2022

How China would like to reshape international economic institutions

By Victor Shih

Despite its size, China has an inadequate voice in traditional Bretton Woods Institutions. This paper examines aspects of the dissatisfaction China has with existing global governance institutions such as the World Trade Organization (WTO) and the International Monetary Fund (IMF). It also discusses the proposed changes to these institutions according to discussions with Chinese experts.

China Economy & Business

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Modernizing the Bretton Woods Institutions for the twenty-first century appeared first on Atlantic Council.

Prepared Remarks

Good morning, everyone. First, thank you, Professor Jackson, for inviting me to this event, to Harvard Law School for hosting this symposium, to everyone here for their interest, and most of all Governor Waller for agreeing to a friendly verbal joust!

I’m now a few months removed from my time at the White House, where my job—in plain English—was focus on strategic challenges at the intersection of international economics and national security. 

And looking back, I’d be hard pressed to think of any topic that better captures the essence of that job than to help shape the future of money—how it’s created, what it’s used for, where it flows, whether it’s seen, and—ultimately—who’s in control. The question before us today is whether and how to pursue a CBDC, and the geopolitical context really matters. We’re having this discussion against the backdrop of most intense period of great power competition we’ve faced in decades—perhaps since World War II—in which the use of economic tools are being deployed with greater frequency and potency than ever before.  This isn’t a conversation that belongs solely within the realm of economic policy or national security. It’s not a technocratic choice that can be made inside the walls of the Federal Reserve and Treasury Department, nor is it a judgment that we should leave to the political, or geopolitically minded parts of the US government. The stakes involved in our digital assets strategy deserve and require an interdisciplinary conversation like today’s symposium, cutting across economics, finance, foreign policy, technology, and the law – so once again I want to thank the organizers for bringing us together.

To be clear, the same blurry line of responsibility exists for a long and growing list of policy efforts at an historical moment in which a nation’s ability to project power—and exert influence—is increasingly measured and exercised in economic terms. Take, for example, US efforts to shape a national innovation strategy—to set a course that sustains and enhances our global leadership in foundational technologies like AI, quantum, biotech, semiconductors, robotics, and hypersonics—each with outsized promise to boost our economic growth potential and military prowess. Or consider the efforts to strike a better balance between the efficiency and resilience of supply chains—such as semiconductors, clean energy, and pharmaceutical products—with critical importance to our economic output and national security.  Or to chart a course on climate policy, trade, corporate taxation, export controls, investment restrictions, global infrastructure finance, and a growing list of strategic priorities that will shape America’s enduring capacity to lead on the world stage. 

The point I’m making is that the challenges of crafting a US strategy around digital money are profound but not unique, and the path forward will require us to balance domestic economic considerations around market efficiency, credit creation, financial inclusion, consumer protection, and financial stability, with our interest in sustaining global technological leadership, the efficacy of economic statecraft, the primacy of the dollar, and the prevalence of democratic values in the global financial system.

Let me say a bit more about the geopolitical backdrop with a few blunt observations. First, both Russia and China—at the highest levels—have expressed and revealed their desire to disrupt the US-led international order. Second, both Russia and China have the capacity to challenge the US led order. China is nearly a peer competitor to the US across economic, military and technological dimensions. Russia punches at a much lower strategic weight than china but it’s  willing to take more risk, its leadership feels more deeply aggrieved by the West, and it has globally systemic relevance in nuclear weapons and energy production. Third, both Russia and China have pressed for a sphere of influence in their respective backyards, perhaps drawing from their shared and stated belief that the US is in structural decline and preoccupied by our own challenges of political dysfunction, social cleavages, and fiscal profligacy. And fourth, as this competition plays out , there’s a sizable group of large G20 economies—India, Indonesia, Brazil, Turkey, South Africa, Saudi Arabia, Argentina, Mexico—that are largely hedging their bets and trying to carve out a non-aligned path. 

It’s in this more fragile and uncertain geopolitical context that we should consider whether China being the first mover among large economies to introduce a CBDC really matters. Let’s rewind. The PBOC began research on the e-CNY in 2014, including on a potential issuance framework and the underlying technologies. By 2016, it had developed a working prototype. By the end of 2017, upon the approval of the State Council, the PBOC began work with commercial entities to develop and test e-CNY’s usage in pilots. The pilot operated in ten regions across China before it was introduced to Olympic Games venues in February 2022. And today, hundreds of millions of active e-CNY wallets are reportedly in operation.

Now it’s often said that Beijing’s motivations for moving first, and moving fast, are primarily internal—to undercut the power of Chinese tech giants that might challenge the authority of the state; to snuff out foreign payment networks such as dollar-based stablecoins and other cryptocurrencies; and most of all, to reassert control over the commanding heights of the digital economy, and in doing so mover ever closer to perfecting a form of digital authoritarianism.

But this narrow conception is less convincing when you consider what China has repeatedly said and done on the international stage. In 2020, President Xi gave a speech in which he ordered his technocrats to take advantage of China’s momentum on developing a digital currency to “actively participate” in the formulation of international rules to shape new competitive advantages. And dutifully, China’s economic diplomats have taken the lead in organizing cross-border digital payments experiments such as the Multiple Central Bank Digital Currency (m-bridge) project with Hong Kong, Thailand, and the UAE—under the auspices of the BIS—giving it a platform and reputational cover to shape global norms and standards for privacy, security, and interoperability. In 2021, the PBOC formed a joint venture with SWIFT, the messaging system that banks use to make cross-border payments, which could allow China to augment its capabilities in cross-border payments systems beyond the homegrown Cross-Border Interbank Payment System (CIPS) it unveiled in 2015.

Now to be fair, it’s not just China that’s moving far and fast. According to the Atlantic Council, 105 countries are actively exploring CBDCs, and 50 of them are in the advanced stages—including 16 of the G20 economies in the development or pilot stage. Along with the UK, Argentina, and Mexico, the US is behind. 

So coming back to the question on the table—do these developments matter for US national security, and why? My judgment is yes, for three reasons.

First, CBDCs have great potential to either enhance or erode the potency of US economic statecraft. As mentioned earlier, we are facing perhaps the most intense competition from major, nuclear-armed powers since World War II. The implications include higher uncertainty, less scope for cross border cooperation to manage cross- border risks, and greater likelihood of conflict—either directly or via proxies—and this will involve more frequent and more potent use of financial sanctions and other forms of economic statecraft—especially when the alternatives—military conflict between nuclear powers, or doing nothing to defend core principles that underpin global peace and security – are generally seen as far, far worse. To be very clear: the potency of financial sanctions hinges on our ability to constrain the access of or fully exclude a rogue actor from the dollar-based financial system, a network that has grown geometrically in value with its size and reach.

Taking this as a premise, what’s the risk of our remaining a CBDC bystander? Consider the scenario in which all countries currently exploring a CBDC eventually issue one. That would mean countries representing upwards of 90 percent of global GDP, not counting the US, will have CBDCs in circulation.  It’s no stretch to assume that each of these countries will establish CBDC-to-CBDC platforms to improve upon the slow, costly, opaque, and complex status quo for cross-border transactions.  Indeed, according to the Atlantic Council, over a dozen countries are actively testing cross-border CBDC exchanges. More to the point, it’s likely that China – the leading trading country in the world and first mover in this space—is well positioned to influence the setting of norms and standards in a competing or parallel digital payment architecture, blunting or even eliminating our ability to apply financial sanctions as we currently do through correspondent banks and SWIFT.

Beijing’s motivation for doing so is clear—in June of this year, President Xi criticized the “abuse” and “selfishness” of international sanctions on Russia, and last year China’s Ministry of Commerce issued measures that allow Chinese citizens to sue parties that comply with “inappropriate extraterritorial application” of foreign measures—including US sanctions.

Now admittedly, the Chinese and Russian central banks can already arrange to make payments with each other that bypass the dollar and could mitigate the impact of sanctions. Payments could also get routed through unsanctioned commercial banks between China and Russia, but their respective payment systems are still quite limited in scale and scope outside their borders. CIPS, the Chinese payment system, counted only about 1,300 members earlier this year, two-fifths of them domestic residents, making China still reliant upon SWIFT for cross-border transactions, and at risk of being discovered in an attempt to evade or backfill sanctions.

So why is a world of CBDCs a potential game changer? It’s the technological scalability of CBDCs that could allow countries to transact far more quickly, in higher amounts, with less detection, and less currency volatility—than they do now.

With this as a premise, it’s not overstatement to say that the standard setting for CBDC interoperability—including the rules that govern exclusion from a CBDC network – will become a key geopolitical front in a digitized global economy. Appropriately, the BIS, as the central bank to central banks, is leading and organizing this effort, and unsurprisingly, China is actively proposing rules for how sanctions would get enforced—or not—in CBDC-intermediated transactions. Put simply, the United States needs a seat at the head of this table, and without a proposal of our own—reflecting our standards, values, and geopolitical interests—we are playing a weak hand. To be clear, when I say proposal—I don’t mean to imply we need a finished product, or even a final decision on whether to issue a US CBDC—but we do need a technological model, or a menu of options, to be taken seriously. In my conversations with central bankers and finance ministry officials, the rest of the world is asking what we’re for as it relates to CBDC interoperability, and it’s an unforced error for the United States not to heed this call.

Second, and to broaden out my first point, we have a strong national security interest to develop a US CBDC to reinforce leadership in digital payments technology, separate and apart from the importance of sustaining the potency of sanctions. That means promoting standards that uphold democratic values as they relate to privacy and human rights; protections against illicit finance; the security and operational integrity of digital architecture; rule of law and dispute resolution; consumer, investor, and market protections; and accessibility for digital platforms, legacy architecture, and international payment systems.

Without our US voice at the table, backed by a viable CBDC prototype in hand, we would likely see a continuing fragmentation of CBDC standards. As mentioned earlier, nineteen of the Group of Twenty (G20) countries are exploring a CBDC, with sixteen already in the development or pilot stage. There are already nine cross-border wholesale (bank-to-bank) CBDC tests and three cross-border retail projects, numbers that are likely to increase in the current geopolitical climate. Even worse than fragmentation would be the coalescing around a global standard that’s at odds with democratic values—for example, by allowing for mass financial surveillance of citizens or the unauthorized sharing of personal information.  This isn’t just a theoretical risk. China’s global dominance of 5G network infrastructure is largely the result of a state-led effort to generate large economies of scale and lock in standards at odds with our interests for security and transparency.

Respectfully, the stakes are simply too high to cede leadership on standards-setting to the private sector—and in backing this claim I would submit the history of financial innovation. Sometimes it works out well. The ATM is the classic example. Electronic payments and microcredit might be others. But we all know more recent horror stories with globally systemic consequences. Subprime mortgage securitization. CDO squared. Unregulated OTC swaps. The lesson we’ve learned the hard way is that governance matters, especially during the period of creative destruction when the applications of a new technology are still taking shape. More practically, based on my conversations with foreign official counterparts, private stablecoins issued from big tech are unlikely to generate the trust that would be conferred to a digital currency backed by the U.S. government. In fact, I would argue it was the potential for private stablecoin issuance to scale at rapid speed that motivated the three-fold increase in CBDC exploration over the past two years.

The third reason why a CBDC matters for national security, and by far most important, is we have an overwhelming interest to reinforce dollar primacy and to minimize even the most remote risks of losing its status. Now I want to take this step by step, because perhaps like some of you, I’ve been frustrated with lazy narratives that foresee the loss of dollar primacy without bothering to connect the dots.

So let me start with the easy part by saying what I hope is beyond dispute—dollar primacy is a national asset that provides incalculable benefits to the United States. It gives us tremendous leverage to absorb a shock (recall the S&P downgrade in 2011, after which the dollar strengthen and our borrowing costs fell), unrivaled capacity to deliver a shock (see sanctions), and to fund our government, households, and businesses at much lower costs than would otherwise be the case (the academic estimates I’ve seen on the borrowing cost advantage for the federal government is on the order of 20-50 basis points on average across the yield curve, which amounts to quite a number on a 20 trillion plus debt stock). So that’s point one.

Point two is that right now, on paper, there’s nothing to see here, nothing to worry about as it relates to dollar primacy. In fact, if I reflect on this week’s discussions at the IMF meetings in DC, the preoccupying question was whether the global economy could bear the unrelenting strength of the dollar. It’s risen more on a nominal trade weighted basis YTD than any other year over the past half a century, excluding 2008 and 1997—both of which ended in tears!

If you look at the traditional measures of primacy—the use of a currency to buy or sell stuff, to borrow money, or to save money. You do see a reduction in the dollar’s share of global foreign reserves (a proxy for saving money) of about 10 percentage points this century, but the dollar is still in a dominant position, 3 times more than the currency in second place—the euro—and almost 20 times more than the renminbi. As a payment currency, the dollar’s share has remained stable at a high level, and the dollar’s share has grown considerably as a source of funds in debt and loan markets. So again – on paper, there’s nothing to see. 

Point three is the steady dominance of the dollar is unsurprising. Why? Two reasons. First, the dollar has become tantamount to the operating system of global finance, with incredibly powerful network effects that generate inertia in its status.

Second, this outcome is by default. Many still worry about existential challenges in the Euro area as it struggles to forge a closer union. Japan has been economically stagnant for decades, with decreasing depth and liquidity in its financial markets. And China hasn’t embraced the kind of reforms that would make the renminbi a credible currency in which to save or borrow money—it still has K controls, it doesn’t have an independent central bank, nor does it have transparent rule of law or an independent judiciary.

Point four. We should take none of this for granted. Like any other asset, dollar primacy will depreciate in value if we manage it poorly.  Let’s recall the conditions that gave us dollar primacy in the first place: strong and independent institutions like the Fed, rule of law, an open system for the flow of trade, capital, people, the ability to innovate, the deepest, most liquid, safest, financial markets in the world, a story that attracts ideas, talent, goodwill, and trust that the US will be a faithful steward with the exorbitant privileges of dollar primacy.

The fact that many across the world are raising the question of whether they can still trust the dollar-based financial system in the wake of our sanctions response to Russia is itself a risk that we should take very seriously. Dollar primacy is nothing more than a network, and all networks have tipping points, often psychological ones that are impossible to identify in advance. And we know from the history of networks – whether they’re in biology, technology, finance, or my son’s eighth grade lunch table—they lose value slowly and then very suddenly. By the time the erosion of dollar primacy shows up in the data, it will likely be too late to stop the process. 

Now let me bring this back to why it matters that we’re a distant CBDC laggard playing an uncertain trumpet. Let’s go through a thought exercise. Imagine that China consolidates and grows its leadership position in cross border payment technology. Why? Well, as I mentioned before, it has a strong geopolitical and economic motivation to challenge the dollar’s unrivaled status.

And, importantly, it’s positioned to offer a better product to address a genuine market need for faster and cheaper cross border payments. Currently, the many steps required to process an international wire transfer are lengthy, costly, and frustrating for the 1 in 8 people across the world that send or receive remittances with regularity. According to World Bank data, average global remittance costs are 7% of the transaction, whereas a DLT-based infrastructure can reduce those costs to less than 1%.  With regard to speed, the Director-General of China’s digital currency initiative said earlier this year that the e-CNY could process 300,000 transactions per second, many orders of magnitude higher than Visa at 1,700 TPS.

Without a competing CBDC issued by a major economy, let’s further assume that the share of cross-border transactions denominated in renminbi continues to converge towards China’s share of global trade, already the highest in the world. With more internationally traded goods invoiced in renminbi, academic research and historical experience suggests we might expect a higher equilibrium level of renminbi deposits and other financial claims held outside of China to undertake these transactions.

If the size of these renminbi claims rises to a material level for China’s trading partners, then government authorities in these countries would have greater incentive to accumulate renminbi reserves as insurance against foreign exchange fluctuations or a sudden stop to renminbi capital flows. As Jeremy Stein and Gita Gopinath have laid out in their research, it’s not hard to imagine a reinforcing feedback loop between these dynamics, whereby the increased use of a currency for cross border trade eventually, or concurrently, leads to greater usage of the currency as a unit of account, and ultimately as a store of value.

In fact, this isn’t just an imaginary scenario. It would follow the historical sequence of events that led to the displacement of the British pound by the U.S. dollar after World War I. As described by Barry Eichengreen, the Federal Reserve Act of 1913 allowed U.S. banks to facilitate dollar-denominated transactions with dollar trade credit,  leading to rapid growth in the use of the dollar for the invoicing and settlement of cross-border trade. In his words: “experience suggests that the logical sequencing of steps in internationalizing a currency is: first, encouraging its use in invoicing and settling trade; second, encouraging its use in private financial transactions; third, encouraging its use by central banks and governments as a form in which to hold foreign reserves.”

Now while I would readily acknowledge that China lacks almost all of the competitive advantages I listed as attributes that gave the dollar its primacy – most of all trust – we should also be clear-eyed that the incentives to hedge against the dollar-based financial system are on the rise in the current geopolitical environment, and CBDCs could very well be a building block in Beijing’s capacity to build a competing or parallel network. Even for those of you who think there’s only a remote chance of my story being true, my response would be this—why take a chance of losing a national treasure? Why gamble our position of strength? Why not fully explore all options to improve our product?

As a concluding point, nothing I’ve said is meant to get ahead of the long list of important design and deployment questions that need to get addressed before the US decides whether to issue a CBDC. Would this be a retail or wholesale CBDC? If the former – where would the accounts reside, what would be the services offered with these accounts, and by whom? What would be the design modalities that limit the disintermediation of the commercial banking system—particularly during times of stress? How would the government, or its agents, protect data and safeguard the operational integrity of the CBDC? What would be the implications for credit creation, both in peacetime and during episodes of stress? Which features would the CBDC include to improve the execution of stimulus provision, whether it’s an automatic stabilizer or a discretionary program put in place during a crisis. And how might a CBDC interact with and co-exist with other digital currencies, both privately issued and those backed by other fiat currencies.  

My message isn’t that we have those answers today. It’s more modest—let’s get on with the work of grappling with these questions, in the best tradition of American innovation, by collaborating across government, academia, and the private sector and committing to develop, experiment with, and refine a CBDC prototype. And let’s do so in the spirit of democratic legitimacy, seeking input from public and private stakeholders and then putting the decision before our elected officials. It may be that our leaders ultimately decide, years down the road, that we don’t need a CBDC, that the process of creative destruction is advancing our national interests just fine without the hand of government. But even for the sake of risk management, let’s not make hope and inertia our digital assets strategy—let’s create a public option, let’s compete, and may the best product win.

The post Full transcript: Former deputy NSA Daleep Singh’s argument for a digital dollar appeared first on Atlantic Council.

But geopolitical tensions have destabilized this relationship. Most recently, the United States was on the verge of delisting more than 150 Chinese companies by 2024. In July, it appeared that Beijing was ready to let go of US capital markets but then, in August, China reached a surprising deal with US regulators, promising to give US regulators access to the audit trail of Chinese companies listed in the United States.

Beijing’s sudden willingness to agree to US regulators’ data-sharing demands indicates that delisting more than 150 Chinese companies is a bigger hit than Chinese private sector can take at this time. However, we don’t yet know whether Beijing will follow through on its side of the deal. 

The deal could also be a ploy to give Chinese companies time to apply for new primary or secondary listings at home or in Europe. Chinese companies’ recent applications for primary and secondary listings outside the United States do suggest they are preparing for a scenario in which the United States confronts Beijing for failing to deliver on its audit-sharing promises.

US and China: Capital markets connection

Listing in the United States has given Chinese companies access to the world’s largest public capital pool and allowed them to gain international recognition, while exposing them to a more diverse group of investors. But the relationship is far from one-sided. American investors are also eager to invest in Chinese companies. 

US stock exchanges have a special appetite for big Chinese company listings, and sometimes go above and beyond to attract them. For example, in 2014, the New York Stock Exchange (NYSE) and Nasdaq OMX Group, Inc. battled over the listing of Alibaba Group Holding Ltd. NYSE went as far as to fly its executives to Hong Kong to make a pitch. Alibaba’s IPO (initial public offering) raised a record $25 billion, by far the largest ever IPO in the United States. Large listings are desirable for stock exchanges because they boost trading revenues more significantly than smaller companies do. Bigger companies trade more and thus provide more exchange fees to the stock exchanges that control their trading. 

Meanwhile, large Chinese companies are keen to reduce their exposure to domestic stock exchanges as these are more volatile and prone to heavy-handed government interventions, negatively affecting investors’ confidence in them. For example, the Chinese stock market crashed in 2015 following rapid gains after the Chinese government’s state media-sponsored campaign actively encouraged investment in the market. Eventually, the media blitz-driven bubble burst and the government was forced to intervene by purchasing huge amounts of stock. 

Recent escalation of delisting tensions

The mutually beneficial relationship between US stock exchanges and Chinese companies has not been without turbulences. In the past two decades, US regulators have demanded transparency and access to audit papers, while China has consistently denied them full access. Tensions escalated in 2020 when then-President Donald Trump signed into law the Holding Foreign Companies Accountable Act. The Act bans the trading of securities in foreign companies whose audit papers cannot be inspected by US regulators for three years in a row. The Securities and Exchange Commission (SEC) expected that, in 2022, US regulators would flag companies whose 2021 audits were not accessible. 

In July 2022 the SEC added Alibaba Group, a Chinese multinational tech company, to the list of Chinese companies at risk of being delisted if they failed to show their audits to US regulators by Spring 2024. Shortly afterwards, five of China’s largest state-owned enterprises—China Life Insurance, PetroChina, China Petroleum & Chemical Corporation, Aluminum Corporation of China, and Sinopec Shanghai Petrochemical—announced plans to delist from the New York Stock Exchange. Chinese officials have stated that the decision was mainly a result of business considerations such as high administrative costs. However, another clear factor is the Chinese government’s lack of willingness to share state-owned companies’ data with US regulators.

On August 26, Chinese and US officials reached an agreement allowing Chinese accounting firms to share more data with US regulators, and potentially preventing the 150 companies from getting delisted in 2024. It turns out China is not ready to lose access to US capital markets after all, and the US is using this leverage to obtain more transparency. 

Whether Chinese companies deliver on the promise and give US regulators full access to audit work papers remains to be seen. In 2013, the United States and China negotiated a Memorandum of Understanding for audit oversight but US regulators never gained full access to Chinese public companies’ records. The precedent of not delivering on the promises in the agreement hints that the same scenario is possible again. 

In preparation for such an eventuality, Alibaba applied for a primary listing in Hong Kong, regardless of the fact that Hong Kong cannot compete with the depth and liquidity of US capital markets. 

Plan B: European stock exchanges

Apart from domestic capital markets, Chinese companies have been eyeing European stock exchanges. Chinese authorities have been working with several European countries to set up programs connecting Chinese and European stock exchanges. For example, in late July, China and Switzerland launched a new China-Swiss Stock Connect program between the SIX Swiss Exchange, and the Shanghai and Shenzhen exchanges. Shortly after launching the program, four Chinese companies operating in energy or manufacturing industries issued global depository receipts on the Swiss stock exchange. While these listings are not initially public offerings, they have opened an avenue for Chinese companies to offer shares in the Swiss capital markets. A dozen more companies have declared their intention to take advantage of the Sino-Swiss Stock Connect program. Thus, European capital markets might become a new destination for Chinese companies. 

Conclusion

The recent agreement between the US and Chinese officials on Chinese public companies’ data-sharing indicates that Beijing is not ready to let more than 150 companies become delisted from the US stock exchanges. While the initial delisting of five state-owned companies made it appear that Beijing was ready to allow more delistings from Wall Street, the process might be much slower than expected. For the time being, US-Chinese capital markets interconnectedness still brings more benefits than harm to both countries’ private sectors. Still, Beijing will continue setting up stock connect programs with non-US stock exchanges while Chinese companies will keep applying for primary and secondary listings in China and Europe. 

Maia Nikoladze is a Program Assistant with the Economic Statecraft Initiative at the Atlantic Council’s GeoEconomics Center.

Related reading

Econographics Aug 3, 2022

Trading geopolitics: The US-Chinese capital markets

By Elmar Hellendoorn

Increased Chinese-Western capital market integration is just one scenario. Instead, ”strong decoupling” or “muddling through” may prove more likely.

China Economy & Business

Blog Post Jan 28, 2022

China’s capital markets in the shadow of the CCP

By Elmar Hellendoorn

Under Chinese President Xi Jinping Chinese capital markers have become increasingly politicized as politics increasingly influence Chinese businesses. This politicization may have significant implications for those investing in Chinese financial assets.

China Economy & Business

Issue Brief Sep 14, 2022

Sand in the silicon: Designing an outbound investment controls mechanism

By Sarah Bauerle Danzman and Emily Kilcrease

The stakes for rethinking the investment relationship between the United States and China are high. An outbound investment mechanism must be narrowly targeted, clearly defined, non-duplicative of existing tools, scoped proportionately to administrative capacity, and paired with meaningful multilateral engagement with allies and partners. 

China Economy & Business

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Companies on the front line: Trends in overseas Chinese listings appeared first on Atlantic Council.

China is a global economic powerhouse, but its system remains opaque. With distress in the property sector, Beijing’s crackdown on technology companies, and the draconian zero-Covid policy being perpetuated through 2022, questions are mounting about Beijing’s economic trajectory. Both policymakers and businesses around the world are assessing how to respond and position themselves. Leaders need a shared language to describe China’s economic system that can be trusted by all sides for its accuracy and objectivity. This is the goal of the China Pathfinder Project.

Building on the framework they launched in 2021, over the past year teams from the Atlantic Council and Rhodium Group have taken a dive into China’s economy to address a fundamental question: Is China becoming more or less like other open-market economies?

To conduct this cross-country comparison, the China Pathfinder report looks at six components of the market model: financial system development, competition, innovation system, trade openness, direct investment openness, and portfolio investment openness. Our annual scorecard places China in relation to ten leading OECD economies to establish a data-centered benchmark for discussion and analysis. It finds China’s progress toward market economy norms slowed in most areas from 2020 to 2021, though not enough to undermine the market opening efforts that took place since 2010. 

China only showed considerable improvement in innovation and trade compared to 2010; the gap was further narrowed as scores for several OECD economies sagged. In other economic areas, the report finds that China is not the only country pulling back from market economy norms. Compared to 2010, we find that backsliding occurred in Australia, Italy and Spain in the areas of financial system development and market competition, while quite a few market economies turned less open to foreign direct investment.

These trends unfold as the world looks to Beijing for its twice-a-decade Party congress. While a third term could free Xi Jinping’s hand to take bolder action in the face of China’s formidable economic challenges, doing so will mean accepting greater economic disruption in the short to medium-term and some loss of control for the Communist Party. Xi’s most urgent domestic task will be to reform the financial system and promote greater market competition. On the external side, greater openness to foreign portfolio and direct investment will be critical. If China’s leadership fails to tackle the structural problems in the economy, growth could languish in the zero to two percent range for a prolonged period.

View the full report below

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

Related content

China Inside Out Oct 5, 2021

The 2021 Economic Scorecard: How China stacks up with the US and its allies

By Josh Lipsky

With China, the story is never so simple. The truth is that China still hasn’t decided which direction its economy is ultimately headed. And we need a credible way to track its trajectory.

China Economy & Business

Issue Brief Aug 11, 2022

China Pathfinder: Q2 2022 Update

By GeoEconomics Center and Rhodium Group

Over the past ten months, teams from the Atlantic Council and Rhodium Group have taken a dive into China’s economy to address a fundamental question: Is China becoming more or less like other open-market economies? 

China Fiscal and Structural Reform

New Atlanticist Oct 3, 2022

Why China’s leadership must respond to the country’s property crisis

By Jeremy Mark

The country’s rapidly metastasizing property downturn threatens to engulf heavily indebted developers, homeowners, financial institutions, and local governments.

China Economy & Business

The post China Pathfinder: 2022 annual scorecard appeared first on Atlantic Council.

The post Global Sanctions Dashboard featured in the CyberWire’s Policy Briefing newsletter appeared first on Atlantic Council.

It remains to be seen whether Pakistan’s justice system will find the wherewithal to adjudicate his case on merit alone. That said, Dar took his oath last Wednesday as finance minister, stepping into the role that Miftah Ismail had vacated a day earlier.

Pakistan has experienced 27 percent inflation this year, the consequence of the country’s persistent refusal to deal with its fiscal or trade deficits, and made worse by extreme fiscal imprudence and political instability. Dar’s first pronouncements as finance minister declared the Pakistani rupee undervalued. He vowed to reduce interest rates, fight inflation, and strengthen the exchange rate—the weakness of which he attributed to speculation.

If these early signals—consistent with his interviews over many months—are anything to go by, Dar and the country’s leadership learned nothing from his last stint as finance minister.

He had been fortunate then to preside over the country’s finances at a time of favorable external conditions: crude oil was especially cheap in the international market between 2014 and 2017, priced at less than half the rates witnessed earlier this year. These lower prices combined with a lower debt burden meant that Dar was able to loosen the government’s purse strings to catalyze growth and lower inflation in the short term. This move was widely panned by economists at the time, who warned about the vulnerabilities that Dar’s unsustainable policies were creating.

Instead of undertaking the long overdue project of serious tax reform, Dar had levied new withholding taxes and customs duties, increased the general sales tax, and over-relied on borrowing to allow the then-ruling Pakistan Muslim League, Nawaz (PML-N) to finance projects of questionable value, such as a large and underused Islamabad Airport that cost about $1 billion.

He had also been responsible for the Finance Ministry at a time when Pakistan was committing to huge new loans to finance the China-Pakistan Economic Corridor (CPEC). History has shown such financial planning to have been very poor. The PML-N government’s chief economist claimed in 2017, for example, that 4 percent of global trade would pass through the Corridor by 2020, with rental fees of $6-8 billion per year paying for CPEC costs. 

Unfortunately, Pakistan’s failure to prudently manage those liabilities has caused distress to its Chinese partners and stalled work on a potentially transformative partnership. While Dar is not solely responsible for the finance ministry’s failures in this regard, he bears significant responsibility as a powerful finance minister over many years critical to the CPEC project.

Finally and most prominently, Dar was single-minded in his defense of the rupee in currency markets in nominal terms, presiding over an inflation-adjusted 26 percent appreciation of the currency between 2013 and 2017. This created the most predictable of consequences: importers, industries using imported raw materials to cater to domestic markets, and consumers went on a spending splurge as imports became cheaper. Exporters lost competitiveness, and exports as a percentage of gross domestic product (GDP) fell more than 30 percent.

Dar thus left a legacy of clear winners and losers. He created short-term stability and a consumption boom at the expense of long-term liabilities and a loss of industrial and export productivity. His exceptionally blinkered focus on a cheap dollar has caused these policies to be labeled “Daronomics.”

In truth, Dar has merely exaggerated the dysfunctional policies adopted by Pakistani policymakers for decades. Simply put: those who could, splurged; those who couldn’t, went to the International Monetary Fund (IMF). There has scarcely ever been another plan.

Consider just the most prominent recent example—the former dictatorship of General Pervez Musharraf—which held the $1:60 rupee rate for years to popular acclaim. What is less well known is that Pakistan’s exports as a percentage of GDP shrunk by a quarter (from 16 percent of GDP to 12 percent) during this time, and that Musharraf presided over an era of secular decline in Pakistan’s industrial productivity. High remittances post 9/11 and dollar inflows related to the War on Terror allowed Pakistan to get out of an IMF program during Musharraf’s reign, but neither tax reforms were undertaken nor fiscal prudence applied. As a result, the country fell back into higher debt at the end of the era.

It is thus hard to see Dar’s appointment as anything but a win for a failed but momentarily convenient style of governance. His predecessor, Miftah Ismail, steered the country’s finances at a time when most commentators feared default. Ismail spoke clearly and passionately about the need for structural reform, and to his credit did try to initiate some corrections, such as pushing for the end of former Prime Minister Imran Khan’s unsustainable fuel subsidy and trying to extract more from undertaxed traders. He was undermined, however, first by Prime Minister Shehbaz Sharif dithering over removing the aforementioned fuel subsidy, and then by Maryam Nawaz Sharif publicly asking him to reverse the attempt to expand traders’ taxes. This latter pushback was particularly damaging, because the tax Ismail had attempted to levy was rather lenient. Unfortunately, the idea of home-grown fiscal prudence and a rolling up of protectionist policies never took serious hold within Ismail’s ruling PML-N party or in its coalition parties.

As such, the former finance minister leaves behind a mixed legacy. 

Miftah Ismail cut an often solitary figure amongst politicians in making the case for reforms, presenting an uninspired budget that almost immediately underwent revisions. He made projections in financial plans that leading macroeconomists have termed incredulous, and was part of the team that sent home a professional central banker without having lined up a solid replacement. Despite these failings, Ismail was a step in the right direction, and showed a willingness to take decisions in the country’s interests at some personal political cost. He is credited with having saved Pakistan from potential default, but was quickly outflanked by status quo forces within his party, which often sniped at him harder than the opposition did. Ultimately, Ismail failed because the PML-N failed to stand behind him.

Dar—the poster child of the status quo—has two advantages over Ismail: he has a reputation for having manipulated the exchange rate in the past, and he enjoys former Prime Minister Nawaz Sharif’s complete confidence. This may allow him to signal the government’s plans more credibly to the market, reducing uncertainty in the short term. In the longer term, however, Pakistan will find it increasingly difficult to absorb Dar’s policies, which are likely to remain punctuated by populist, short-term efforts to arrest inflation and the exchange rate at the expense of deeper reforms.

If the international commodity super-cycle ebbs and there is substantial influx of foreign support for post-flood reconstruction, the temptation will be high for the new finance minister to play Daronomics again, to the detriment of Pakistan in all but the shortest of short runs.

Dr. Ali Hasanain is an Associate Professor of Economics at the Lahore University of Management Sciences (LUMS) and a non-resident senior fellow at the Atlantic Council’s South Asia Center.

The South Asia Center serves as the Atlantic Council’s focal point for work on the region as well as relations between these countries, neighboring regions, Europe, and the United States.

Learn more

Related content

Report Oct 3, 2022

Pakistan sees growing culture of innovation amid tech startup boom

By Hamna Tariq and Uzair Younus

A tightening global macro environment coupled with increasing domestic political instability is a cause of concern for the sector, especially the domestic startup economy.

Economy & Business Entrepreneurship

SouthAsiaSource Sep 9, 2022

Experts react: Catastrophic flooding in Pakistan

By South Asia Center experts

More than one-third of Pakistan is underwater amid catastrophic climate change-induced flooding. South Asia Center experts provide their analyses of the situation.

Climate Change & Climate Action Economy & Business

SouthAsiaSource Aug 12, 2022

Pakistan at 75: Learning from history to chart a better future

By Uzair Younus and Ilhan Niaz

As it celebrates seventy-five years of independence, Pakistan today “requires a change in political thinking across the political class,” says historian and author Dr. Ilhan Niaz.

Conflict Migration

The post Pakistan must learn to live without ‘Daronomics’ appeared first on Atlantic Council.

This was the second in a series of four events for the first cohort of the WIn (Women Innovators) Fellowship launched in Saudi Arabia. The fellowship is led by the Atlantic Council’s empowerME Initiative in cooperation with Georgetown University’s McDonough School of Business with support from US Embassy Riyadh, PepsiCo, and UPS. The American Chamber of Commerce Saudi Arabia’s Women in Business Committee is the program’s in-person event partner. The yearlong program, which is takeing place from March 2022 – March 2023, enables more than thirty Saudi women entrepreneurs to enhance their networks, gain practical knowledge, and develop US-Saudi people-to-people and business ties that will help them scale their business locally, regionally, and globally.

The key points from the discussion are summarized below.

Major changes in Saudi Arabia’s legal landscape that impacted women in recent years

• Imad Al-Abdulqader explained that many wide-ranging changes in Saudi Arabia are occurring simultaneously: “The transformation is a combination, part of five main things: social changes, regulatory changes, restructuring of government, digital formation, and eliminating bureaucracies.” He also noted that the diversification of the economy is also a key change underway, and all these shifts have synergy and build on each other.
• Al-Abdulqader said that “the most important change…happened in July 2019 when the government went through different laws and regulations, line by line, and struck out anywhere that says a woman needs somebody’s permission to do anything.” This allowed women to gain independence, including equal travel and mobility rights. He added that in 2016, “One of the best things that happened was the removal of the Committee for the Promotion of Virtue and the Prevention of Vice.” This committee was enforcing a strict interpretation of a moral code that wasn’t written down anywhere, he explained, and its dismantlement helped propel women’s independence and equality in work. In addition, in 2017, the Ministry of Labor issued sexual harassment laws for the workplace that protect women from unwanted advances.
• Afnan Ababtain agreed with Al-Abdulqader and noted that the data shows how much Saudi Arabia has changed. She said: “In 2016, the percentage of women [leading their own startups] was less than 21 percent, whereas today we’ve reached 45 percent.” Moreover, Saudi Arabia’s Small and Medium Enterprises General Authority (Monsha’at) had a clear goal to “increase Saudi women in the workforce from 20 percent to 30 percent” and the country has “passed that goal by achieving 33 percent female workforce participation,” said Ababtain.
• AlZouman asserted that PepsiCo is a huge advocate for diversity, championing it both internally and externally. She noted that PepsiCo has lines in their plants operated fully by women and that the company has women executives. When reforms in the Kingdom accelerated, she said: “PepsiCo changed our work culture; we implemented programs to help newly starting female laborers to adjust to the workplace.”
• AlZouman also explained the ways the laws support women in the workplace. For example, if a workplace has more than fifty employees, they are required to have an on-site daycare for women employees.She stated that “the labor laws are extremely protective and enabling in the workplace” and that she feels extremely supported by them. She added that at times she’s even felt the laws give unfair leverage to employees rather than employers.
• “Thinking about the situation when I first started my career in 2010, and then seeing how everything is right now, it’s extremely surreal I cannot believe it. It’s like a cultural shock while I’m living it. Thank God, its going in the right direction”, AlZouman reflected on her 10+ years career in Saudi Arabia. She explained how when Saudi companies first started implementing new work reforms, it was a challenge. However, due to the persistence of women like her, employees are starting to adjust to these social changes.

Areas where change is still needed to boost women’s workforce participation and ability to start businesses

• Ababtain explained that Monsha’at works to empower female entrepreneurs by “looking into the existing women who are in the market” to understand what kind of challenges they are facing. These challenges could be recognition, access to the market, or access to finance. She discussed the multiple ways Monsha’at offers support to women entrepreneurs: free consultations at four SME support centers throughout the country, access to finance, and a free app for mentoring. She said that Monsha’at also encourages women with traditional businesses to incorporate technology into their businesses, and she noted that Monsha’at encourages women entrepreneurs to start childcare businesses given the laws requiring many companies to provide this service.
• Because of the rapid change, some parts of the society may still be resistant to the new landscape. Al–Abdulqader pointed out that there are ways to accelerate this new reality. “Depending on what sector or position you’re in, it will move at different speeds but still move forward. For example, seeing more representation of female leaders will accelerate this new norm.” He added that the “private sector is a little behind, but they will catch on.” As time goes on, the Kingdom will inevitably encounter bumps just like any or nation undergoing a huge transformation would, he added.
• Ababtain mentioned the importance of ensuring gender equality in leading companies, noting: “Although 45 percent of business owners in Saudi are women, we want to ensure that these are quality businesses” to make sure that all their hard work isn’t going to waste.
• While the government has been investing in women’s higher education for decades, Al-Abdulqader pointed out that in the past, “women’s employment was limited to health care and education for girls.” This has already begun to change, especially as more sectors such as tourism and entertainment develop rapidly, opening up new employment possibilities.

Amira Attia is a Program Assistant with the Atlantic Council’s empowerME Initiative at the Rafik Hariri Center for the Middle East.

The post New laws in Saudi Arabia support women in business, and society is catching up quickly appeared first on Atlantic Council.

Flagship Event Wed, September 28, 2022 • 2:00 am ET

Highlights from the 2022 Frankfurt Forum on US-European GeoEconomics

Explore key moments from the inaugural forum, presented in partnership with Atlantik-Brücke, including keynote remarks from European Central Bank President Christine Lagarde.

Event transcript

Uncorrected transcript: Check against delivery

PAOLO GENTILONI: Thank you very much. Thank you all. A pleasure to join you, and unfortunately only virtually. This is Wednesday, day of college here in Brussels.

Of course, we all know that the EU and US relations are deep, with strong ties. And after the Second World War, we always, in difficult times, we were able to stand side by side. So again, since February, we have come together to impose unprecedented sanctions against Russia, to provide crucial military and financial assistance to Ukraine, and to weaken Russia’s grip on our energy markets.

Is our common response working? In my view, definitely yes. The sanctions are eating away at Russia’s economy, which is set to shrink markedly both this year and next year. Russia’s own Federal Labor Service has stated that three thousand brands have put business on hold since the invasion, with five hundred foreign companies having been liquidated by the end of July—five hundred. Russia’s imports from the EU fell by around 50 percent in the period March-June. Russia’s imports of IT equipment have tumbled, despite its legalization of parallel imports. Blocked access to updates of Western software, absence of spare parts and semiconductors are having a grinding effect on the industry.

Many of the few cars produced in Russia—data over the summer indicated that sales were down by more than 70 percent compared to the previous year. Most of these few cars are without airbags and catalytic converters.

Russia’s share on EU gas imports has fallen by two-thirds, from 45 percent before the war to 14 percent now. And its share of our pipeline gas imports has fallen by three quarters, from 40 percent to 9 percent. The deals that we have struck with the US and other partners to boost energy imports have made up for the cuts in Russian fossil fuels.

I am mentioning these figures because I think we need always to repeat how successful was our common effort to respond to the Russian invasion with economic sanctions. And now the cap on the price of Russian oil exports that was agreed in principle at G7 level and was mentioned in the previous panel will put downward pressure on global energy prices and reduce the Kremlin’s ability to fund the war. And today we are setting out the legal basis to implement these key measures in the EU.

So overall our common response is working. And I have to say that Russia’s recent moves, from halting gas deliveries to the mobilization of their reservists and sham referendum, are clear signs of weakness and growing desperation. Of course, they are also sign of escalation, which we are responding with other packages, the eighth sanction package that was just announced by President von der Leyen here in Brussels.

On the economy, it’s clear that the consequences of the war are weighing on economic prospects on both sides of the Atlantic. A combination of high energy price, high inflation, monetary tightening, and uncertainty are putting a damper on growth. Both EU and US will see positive growth for the year 2022 as a whole, but all the signs are there of a slowdown. And a recession can no longer be ruled out. We are entering the phases of stagnation and possible recession.

So, to ensure—to navigate in these troubled waters, we need to maintain our responsible fiscal policies and at the same time our efforts of investments. For Europe, the NextGenerationEU remains the strongest common tool at disposal, and this is why I have made clear that while we are open to discussing limited and specific points, there should be no wholesale re-opening of plans of recovery or postponing of key commitments.

In this context, let me conclude these remarks with three lessons or priorities for the future of our transatlantic relations. First, of course, our strength lies in our unity. Within the EU—and you know how challenging it is to keep our unity with our likeminded partners across the Atlantic and beyond. In the months ahead, this unity will be tested again and again, and we must stay the course.

Second, in an increasingly multipolar world, the EU and US must continue to work together every day—and not just in times of crisis—to show that liberal democracies can deliver sustainable and inclusive growth, and this is happening. I think that the arrival of the Biden administration marked a qualitative improvement in these multilateral relations.

Our agendas are very much aligned. In Europe, we are pursuing an ambitious part of investments and reform to deliver on the triple transition—the green, the digital, and the social. I think that the Inflation Reduction Act in the US goes in a similar direction. As you know, we are also looking more broadly on how our fiscal roles can better support investments in crucial areas while making sure that level remains sustainable, and we will present our proposal in this next month.

Going forward, there is also hope to strengthen our trade cooperation knowing that the disruption to global supply chain must galvanize us to build safer, more resilient supply chains—especially in strategic sectors—but this doesn’t mean in any sense going to protections.

Third and last lesson, transatlantic cooperation is necessarily but not sufficient condition to tackle the challenges ahead of us. For that, we need to master much wider coalitions.

Russia has openly challenged the rule-based international order. This is not a Western order. It’s an order that is in everyone’s interest to uphold. Yet, thirty-five countries, as you know, including three members of the G20, decided to abstain in the U.N. resolution condemning Russia’s invasion of Ukraine.

So, we have to increase our reach out and influence in other parts of the world. This is the key objective for the EU of the Global Gateway Strategy to mobilize… investments across the world, in line with the G7 Partnership for Global Infrastructure.

We also need to work for a more effective multilateralism. There’s a great example that we have now to implement. It is last year’s global agreement to reform our global corporate taxation—an agreement that was made possible because everyone worked in a spirit of compromise to find a common solution. And I’m confident that this spirit will lead it too, and this spirit is alive and can guide us in meeting the common challenges we face.

So, thank you very much for this opportunity, and I’m happy to answer your questions.

ANNETTE WEISBACH: Commissioner Gentiloni, thank you very much for your deliberations. Let me, first of all, ask you about what happened today in Brussels because clearly President von der Leyen has presented a new round of sanctions, a package, and also news on potential oil price caps. Perhaps you can give us the latest what’s discussed in Brussels.

PAOLO GENTILONI: Yes. Indeed, we are working on the eighth package of sanctions. The main aspects of this package of sanctions are probably three. The first, we increase our listing of Russian persons or entities. They are now up to 1,025 persons, and seventy Russian entities. And this is the first part. The second part will be increasing of trade limits towards Russia. And the third, that I heard mentioned in the previous panel, is the agreement of G7 level on the price cap of oil.

Of course, this means that we will work especially on the sector of the shipment insurance to make sure that there is an agreement to avoid contracts, if oil is transported at the higher price in relation to the cap that we will establish at G7 level. As always, the decision making in the European Union is a process. We don’t have executive orders. But I am quite confident that, again, this new package of sanctions will be supported by member states and will enter into force.

ANNETTE WEISBACH: What do you think—when will those price caps, also for the energy of electricity and gas market, will get implemented and so consumer will finally benefit from it? Because we’re heading into the winter period.

PAOLO GENTILONI: Well, of course, we worked a lot in the previous months. And indeed, there were metrics and figures in my remarks, also to remind myself and everyone of how much we were able to achieve in these few months. If you look at the fact that we go from 40 to 9 percent, and maybe we are now even less than 9 percent, about gas coming from Russia. This is quite substantial. You know that we have very high level of storage.

We are working on mandatory savings among member states, of course, with different ways of reaching these mandatory targets. And next Friday, the Council of Ministers of Energy will address the—also not only these issues, the issue of solidarity contributions, the so-called price limits… but also the issue of a price cap on gas. I’m sure that this discussion will be, as always, with different opinions. And I am confident that Friday will put the basis for a final agreement in October in the European Council to introduce a limitation of price for gas.

My final remark is, we should, I think, avoid raising expectation of the fact that these price limits will automatically bring energy prices to a pre-war situation. It will be a gradual process, but it’s very important to start this process of limiting these prices.

ANNETTE WEISBACH: Let me also ask you about the cooperation between Europe and the EU and the United States, because clearly we are here at the Atlantic Council. So how is cooperation going, and how confident are you that perhaps there might be more LNG deliveries from the US into Europe?

PAOLO GENTILONI: One, we had a very important agreement—President Biden and President von der Leyen a few months ago agreed on supply of LNG. Of course, when we refer to capping prices of gas, we are referring mainly to gas reaching the Union—the European Union through pipelines. And of course we are not putting at the same level Russia and Norway, or Algeria, or Azerbaijan because, of course, with Russia we have a double intention to keep the prices—to limit the prices but also to undermine the war machine of Russia.

Different is the situation for LNG, where we will cooperate with our partners and with the US both on supply and possibly on making differences of prices for European and Asian markets less dangerous than the one that we are seeing now. By the way, this difference between the Asian and the European market on LNG is changing months per months, so I think we have to address this issue with our partners. This is a different story from the capping of gas and from the pipelines.

ANNETTE WEISBACH: Aside from that energy crisis we are currently facing, there has been also political developments in the EU, which at least is interesting, also for an international audience. The election outcome in Italy—I know you are also from Italy, so it might be a bit tricky for you to answer that question, but I’ll at least try and ask it.

So what do you think will be the ramifications from the outcome of the elections in Italy?

PAOLO GENTILONI: Well, the—of course I have a conflict of interest, so I have to—once we are questioned as European Commissioner—

ANNETTE WEISBACH: Yes.

PAOLO GENTILONI:—not as a former Italian politician.

As European Commissioner, I would simply say that we are of course ready to cooperate with the old governments, including the coming Italian government. Now, of course, I could add that, as the Latin motto goes, “pacta sunt servanda.” So we have a very important cooperation on the recovery, and we have our common rules. You know that these common rules, by the way, are under review and discussion, and what we ask of all European member states is give their contribution, to have their view, but to stay to the facts that are ruling our union. I am confident that this will be the case also for Italy, and we are ready to cooperate…

Watch the full event

The post Full transcript: Paolo Gentiloni on signs the West’s sanctions on Russia are working—and the new packages on the way appeared first on Atlantic Council.

Flagship Event Wed, September 28, 2022 • 2:00 am ET

Highlights from the 2022 Frankfurt Forum on US-European GeoEconomics

Explore key moments from the inaugural forum, presented in partnership with Atlantik-Brücke, including keynote remarks from European Central Bank President Christine Lagarde.

Event transcript

Uncorrected transcript: Check against delivery

MARIA DEMERTZIS: Good morning, ladies and gentlemen. Welcome. Also, a very warm welcome from my side.

My name is Maria Demertzis. I am the deputy director of Bruegel, which is a think tank—an economic think tank based in Brussels, and I’m delighted to be here. Thank you to the organizers for including me in the program. And of course, I am delighted to host President Lagarde, who needs no introduction.

President Lagarde, there’s a lot to talk about. If I may start with just the title, as you see, the Frankfurt Forum is a forum that is a conference that concentrates on the US-European economic and geoeconomics relations. We’re here to talk, I’m sure, about inflation. Inflation is a problem. And I wanted to quote Chair Powell, who said that inflation is a global phenomenon even though the sources and the way that it’s felt in different parts of the world are actually quite different. Do you share his view in this respect?

CHRISTINE LAGARDE: Well, first of all, good morning. Good morning to all of you in the audience. And my great thanks to you, Fred, for a flattering introduction, but for standing as a leader in the European-Atlantic relationship, which matters so much. And I’d like to extend a special thank you to Josh and Julia. They’re in the back of the room and they have been instrumental in getting us all together.

So back to Jay’s—to Chairman Powell’s—view. It is a fact that we have inflation pretty much across the world—including in Japan, where it was so low for so long. Even there, we are seeing it. But we’re seeing inflation in different shape, form, and levels, and I think it has a lot to do with the roots of that inflation.

So if I—if I concentrate only on Europe—and I will say “Europe,” but it’s obviously the euro area, where we are welcoming our twentieth member on the first of January because Croatia will be joining the euro area and will become a full-time member of the European Central Bank—if I compare Europe with the United States, the roots of inflation are different. And I think it matters to understand where it is coming from so that we can adjust the monetary policy response accordingly.

So the two key differences that I would—I would see is—have to do with energy and labor.

If you look at energy, it is the key driver and has been the key driver of inflation in Europe. Rough speaking, if you take the direct impact of energy—and by energy I mean, you know, electricity, gas, all petrol-related products—if I look at that plus the indirect impact of energy costs, you’re talking about roughly 60 percent. So 60 percent of the drivers behind inflation here are related to energy. If you look at the United States, it’s about half of it. If you put food on the top, we are more impacted as well by food because of the way we are organized. The US is less impacted. So the drivers are predominantly energy-related in Europe and not as much in the United States.

The second factor which also has an impact is that when you look at wage progression, you see that wages in the United States progress anywhere between 5 and 7 percent at the moment. When we look at wages negotiated in the last few months, we are between 2.5 and 3 percent. So that’s also a major difference in terms of second-round effect that we have to be very attentive to.

Those are the two key differences. And if you add to that the economic analysis of is it supply-driven/is it demand-driven, clearly our inflation is strongly supply-driven. So we have shortage of supply for various reasons—you know, the supply-chain bottlenecks that have affected us critically at a time when the recovery was, you know, taking its full flight and at a much faster pace than expected. When you look at the United States, because of the wage point that I was making it is much more so demand-driven.

And that has—that has consequences to how we deal with it. And in a way, when you have predominantly or purely demand-driven inflation, I wouldn’t say that it’s fairly simple but you have to hammer demand, reduce it, so that it realigns with supply. When you are predominantly supply-driven, it’s far more complicated because monetary policy cannot in and of itself reduce the price of gas, cannot stop the war as much as I would love for us to be able to do that. So we need to be attentive to—

MARIA DEMERTZIS: If I may—I mean, I suppose my question is, it took a little while before action came in this respect, right? I mean, at Bruegel, we started monitoring the fiscal health that people were—that countries were giving to, both to companies, as well as to households, back in September of last year.

CHRISTINE LAGARDE: Mmm hmm.

MARIA DEMERTZIS: And so, we knew that the inflation was going to be a problem. Yet it took a long time to get there. Why did it take so long to come here?

CHRISTINE LAGARDE: Well, first of all, we started that journey of normalizing monetary policy in December. So, yes, it could have been September, but we started the journey in December. In December, we decided that we were going to reduce net asset purchases, stop net asset purchases, whether it was under the normal asset purchase program, or under the pandemic emergency program that we put in place—rightly so, in my view—in order to deal with the phenomenal crisis that we faced. But we decided to stop net asset purchases, and as soon as net asset purchases had stopped, then we decided to move out of negative interest rates—in which we had been since 2014—and then to hike again.

So, we decided in a matter of two monetary policy meetings, six weeks apart, 125 basis point increases. So, you know, I’m not—I’m not challenging that we made some projection errors—like everybody else who was doing projections, maybe because many of us are using the same models. But no one understood—I’ll take you back a little bit further. You mentioned September of that year. I’ll take you to December. So, eighteen months ago, roughly, eighteen months ago, I’m sure that very few in this room remember where inflation was. It was in negative territory, December 2020, minus three [percent]. Now, we are at plus 9.1 [percent], the last reading of October. Minus-0.3 [percent], sorry.

MARIA DEMERTZIS: Minus-0.3 [percent].

CHRISTINE LAGARDE: Minus-0.3 [percent]. But negative. We are now—last reading, at 9.1 [percent]. And our forecast for this year is a little north of 8 [percent], for the whole year, and moving towards 5.5 [percent] next year.

So, yes, I think there was a general sense for a period of time that this inflation, that was generated by the rotation of demand that we observed right after the recovery, from, you know, massive purchases of goods, to pent-up demand in services, in particular, we—many of us, I would say, pretty much all projectionists assumed that it was going to be transitory, because in the textbook, supply bottlenecks eventually fade out. Energy prices eventually return. Well, this didn’t happen. And what we are seeing and have been seeing for the last few months, and accelerated by the war in Ukraine, has been more persistent and of a magnitude that nobody had expected. But we started that journey in December.

MARIA DEMERTZIS: With the normalization, yeah.

Well, we are here now.

CHRISTINE LAGARDE: Yup.

MARIA DEMERTZIS: And the inflation is a projected 5.5 [percent], as you said, next year. I’m not going to comment on the forecast. I think that—I mean, there are—there are so many things we can say about forecasting, but in any case we have to deal with the tools that we have.

CHRISTINE LAGARDE: Yeah.

MARIA DEMERTZIS: But one thing we do know is that whatever we do now is not going to come into effect for another year and a half.

CHRISTINE LAGARDE: Yeah.

MARIA DEMERTZIS: It’s going to take a long time to get—to see the effects of the decisions that we take now. That’s why it was important to ask the question where we lay in starting, you see.

CHRISTINE LAGARDE: Yeah.

MARIA DEMERTZIS: But so my question to you now is—and given that now we have to wait for another eighteen months to see the effects—and now you are, actually—I think you are decisively increasing interest rates –

CHRISTINE LAGARDE: Mmm hmm.

MARIA DEMERTZIS:—are you afraid that maybe there will be stifled growth? Because you know, in a year and a half from now, maybe this war is over—I hope this war is over. Maybe the energy issue has normalized. Is it correct to now increase rates at quite the speed that we think is—increases are going to happen?

CHRISTINE LAGARDE: Returning stability of prices is the mission of the ECB. This is our primary objective, stated in the treaties as I have just said, and this is what we have to do, returning inflation to 2 percent in the medium term.

And we will do what we have to do, which is to continue hiking interest rates in the next several meetings, as I have said at our last monetary policy meeting. We have to deliver on that.

So, our primary goal is not to, you know, to reduce growth. Our primary goal is not to put people on the dole. Our primary goal is not to create a recession. Our primary objective is price stability, and we have to deliver on that. If we were not delivering, it would hurt the economy far more than if we do deliver on that point.

MARIA DEMERTZIS: So, if I may, you are trying to, so, ensure that the inflation that we see is not entrenched.

CHRISTINE LAGARDE: Yeah.

MARIA DEMERTZIS: You say 60 percent is supply-driven; the rest is, if I may call, demand or other things that are happening.

CHRISTINE LAGARDE: Yeah.

MARIA DEMERTZIS: So your hikes are there to prevent inflation from being entrenched, I think.

CHRISTINE LAGARDE: Yeah. Yeah, because what is—we are all seeing it. And thank you again, President, for hosting us at the chamber. It’s wonderful to be here in proximity of those who are in the trade, in the business, industrialists. In the business, there are wage negotiations taking place. There is anxiety on the part of those who see the bill at the end of the month, and with the electricity and the gas prices increasing. So, those who sit at the negotiation tables need to appreciate that in the medium term, inflation will be returned to 2 percent.

And that’s what I mean by working on the inflation expectations, because we are very attentive to that. We not only look at what the models tell us; we look at what our scenarios tell us. We do sensitivity analysis. We look at surveys. We try to understand exactly what is in investors’ minds, in consumers’ minds, to see where it’s heading. And we need to make sure that those inflation expectations stay anchored at 2 percent. But that’s really an important part of the job that we have to do at the moment, because we can impact second-round effects, more difficult to impact the first-round effects when they are, you know, predominantly energy-driven.

MARIA DEMERTZIS: President Lagarde, I want to ask you a question on communication. I know you care deeply about communication, and about direct and clear communication.

CHRISTINE LAGARDE: I try. No, absolutely.

MARIA DEMERTZIS: The issue of forward guidance, the issue of telling us what you’re going to do in the future—you also just told us right now—I was personally surprised to see that you had told us that you’re not going to tell us what you’re going to do, and then you told us, we will tell you what we are going to do.

At the same time, you put a lot of emphasis on the issue of uncertainty. We don’t know what’s going to happen; we don’t know where we’re going. And my question to you is, I mean, how should communication be adjusted? That quite well the degrees of uncertainty that we have out there are so, so big, when we don’t know where we’re going, can we not go there slower? Or should we go faster? And how should you adjust your communication, when actually the future is quite so uncertain?

CHRISTINE LAGARDE: You’re totally right that the future is extremely uncertain, and that’s the reason why we decided that we would decide, meeting by meeting, on the basis of the data that we receive. And I think that in such uncertain times, to rely exceedingly on forward guidance would be a constraint and would not be good communication, because if you communicate in terms of forward guidance that you are going to do this or that at such time, it will be state-dependent, it will—and uncertainty results in completely—in a completely different situation from what you had anticipated in your models, in your scenario analysis, in your sensitivities analysis.

Then, your forward guidance was wrong; you misguided those who carefully listened to you. So, we think that in those uncertain times, and as we are no longer at the effective lower bounds—so very, very low or close to that effective lower bound as we were—it’s probably much safer and much more accountable to our mission to be data-dependent, and to decide meeting by meeting.

Now, I gave a little bit of forward guidance by saying that—and I think it’s based on sufficient analysis and facts—when I said that after the 125-basis-point hikes of interest rates, that there will be more interest rate hikes in the next several meetings because we are—we are not at the neutral rate yet. We are—this is our first destination on the journey, but we are not there. And we have to move there first and then see what rate will deliver us the 2 percent inflation objective that we have for the medium term.

So there is a little bit of forward guidance. It doesn’t say by how much. It doesn’t say the number of meetings. But it’s a clear indication that we are on a—on a path the pace of which, the volume of which will be determined on the basis of data and meeting by meeting.

MARIA DEMERTZIS: If I may, I would like to move on to another topic, subject of conversation that has actually kept us busy for some time, and that is the new and different anti-fragmentation tool.

CHRISTINE LAGARDE: Uh-huh.

MARIA DEMERTZIS: I think that’s actually something that has created a lot of fans and a lot of those who are very critical about it. But I want to start by asking you: Why is there a need for a new tool? Don’t we have enough tools?… There are different ways of dealing with the fragmentation risk. Why is there a need for a new tool?

CHRISTINE LAGARDE: We believe that not only should we deliver on monetary policy, but we must ensure that monetary policy is delivered across all member states. So if there is—if our—if the reaction function applies predominantly in, I don’t know, you know, ten out of nineteen countries or twelve out of nineteen countries, we haven’t done our job. It has to apply throughout the entire euro area.

So I think the Transmission Protection Instrument is precisely aimed at that. If we see—if we assess that because of market dynamics that are unwarranted our monetary policy is not transmitted throughout the euro area; and if the four criterias that we have put in place, which predominantly you can summarize as a well-behaved country by the rules of Europe; and if it is a proportionate instrument to use, in other words it will serve the purpose that we have of transmitting monetary policy; then the Governing Council, in its collective wisdom and of course borrowing the analysis of other institutes of quality and good standing, will trigger the Transmission Protection Instrument and will do so. It’s one more instrument that we have in the toolbox. And it’s intended for that specific purpose, unwarranted market dynamics.

We do have other tools. And you know, if the TPI has been used for the results for whatever cause that is, then there will be other tools that we can use. And they are completely alive and available as well, and we will use all instruments of monetary policy in the toolbox in order to deliver on the primary objective and make sure that it is transmitted across the euro area.

And it’s not intended for one country or the other. You know, the world turns and we have to be attentive to all nineteen member states.

MARIA DEMERTZIS: But if I may, the unwarranted part is, of course—how are you going to apply this? What is unwarranted? And how do you go about identifying what is unwarranted? I mean, this is—I mean, the tools that we have in our—in our hands, do you think they will give you the confidence to say something is warranted by fundamentals and something is not warranted? And with that—if you could comment on that, that would be interesting. But also, with that, a very important—one of the four criteria that you have there is that there is—the debt behind the countries is sustainable.

CHRISTINE LAGARDE: Mmm hmm.

MARIA DEMERTZIS: And you say that you are going to do your own analysis, but also do the analysis—look at the analysis of other institutions and come to a conclusion. If I may ask a little provocative question, but the debt sustainability of a country is as much economics as it is politics. And don’t you think it would be better, certainly for the reputation of the central bank, to let other institutions decide what is sustainable and what is not sustainable? Why did you have a need to decide on yourself to do that?

CHRISTINE LAGARDE: First of all, because a central bank in current times is an independent institution, and I have to respect the collective wisdom of twenty governors and the Executive Board members around the table whose job it is to deliver on the mission. So it is the independence of the central bank to use the appropriate tool on the basis of a process that we have identified in relation to TPI, the three-step assessment process and the four criterias, one of which is fiscal sustainability.

And that is intended not, you know, for us to suddenly become the ultimate judge of sustainability. Because we will, obviously, use the analysis produced by institutions like the IMF, like the ESM, like the Commission, to name a few because they do produce excellent analyses—not always on the same page, you’re right, and there is a political dimension to it, absolutely, but you can try to eliminate as much as possible the political biases when you use several institutions.

You know, I was—as an anecdote—and I have some former IMF colleagues in the room. They will remember those days when the Commission was publishing a debt-sustainability analysis, when the IMF was publishing an IMF debt-sustainability analysis for a country. And then we would go and visit the country, and that country would say, oh, I have a completely different analysis from yours and this is, you know, smoke and mirrors. Well, in all fairness to those who are technical experts, they can really reduce the uncertainty to a minimal portion. And the fact that we are cross-checking and cross-referencing our own understanding—because we do have quite a few good analysts ourselves—and those produced by other reputable institutions, I think, is the best guarantee we have of producing something that is independent because that’s clearly a necessity.

MARIA DEMERTZIS: Thank you very much, President Lagarde.

Given the time, if you’ll allow me I want to move into two more things, simply because they will be discussed very much today later in different sessions. One is the international role of the euro, exchange rates and how much you can see the euro becoming more of an international currency. And the other one is the digital euro. So let me take them one by one.

CHRISTINE LAGARDE: Mmm hmm.

MARIA DEMERTZIS: There is actually going to be a session later with—Martin here has—will present a very interesting paper on the international role of the euro. If you look at the international reserves, the euro reserves internationally have been about 20 percent for the longest time. So 60 percent the dollar, 20 percent the euro. Do you think that there is a scope for the euro to take a bigger role? And, in fact, should it?

CHRISTINE LAGARDE: You know, I can’t help saying that the euro is the second international currency of reference. So 60 percent for the dollar, 20 percent for the euro, and the rest—the other 20 percent are allocated differently. You know, you’ve got sterling, Swiss francs, renminbi of course, yen. So to remain the second is something that we should acknowledge.

Can we do better? I’m sure we can. But in my humble view and with tribute to Martin Mühleisen’s paper, which is really interesting and I would concur with him on many points, there are three key attributes for a currency to become THE international currency, if you will, or one of the main—that is, more than 20 percent.

First of all, you need a large, sizeable economy. That’s what I would call the weight. It has to be solid and large. I think, you know, Europe satisfies that criteria.

The second one is the stability of all its institutions, of its economic framework, which gives predictability to those who trade and invest. You could dispute that in a few corners, but I think in the main Europe also has to offer that stability.

The third one—on which, in my view, we are short—is the depth of its financial—of its capital market. And you know, many European leaders advocated—I don’t see many European countries actually moving forward with the project of really delivering on a European capital market that would be a union capital market. So we have good markets. Let’s get it right. There’s a good capital market in Germany. There’s a good capital market in France. There’s a good capital market in all those countries. But there is no Union capital market where you can, you know, move smoothly from one to the other. And I really hope that we can achieve that.

Now, of course, what do we deal with? The rivalries between places. We deal with the rivalry between authorities that supervise those markets. We deal with political sovereignty that is often associated with a member and not with the union. But we are not helping our cause of being stronger and more powerful as a currency if we keep on dealing with a fragmented market as we do. If you talk to investors, they say that very clearly. That, in and of itself, would not be enough to make us totally efficient, and the union would have to be deeper in other respects. But the capital markets union is really an element that is missing in the three pillars that I associate with a very strong international currency. The United States has all three, no question about it.

One more point about this. There is research now that really points in the—in the direction of the relationship between trade and reserves. In other words, the more you trade in dollars, the more dollar reserves you want to have. The more you trade in euros, the more euros you generally have in your reserves. So there is a linkage between trade and reserves.

By the way, we in the euro area, we benefit from the union in that respect because about 60 [percent]—and I stand to be corrected, President, because I’m sure you have the trade numbers better than I do. I used to have them well. But about 60 percent of the trade that we conduct is actually within and between members of the euro area, and we trade in euros. We don’t trade in alternative currencies at home within the euro area. So there is a portion of our trade that is exposed to FOREX risk, but 60 percent of it is within the euro area.

MARIA DEMERTZIS: So just to be clear, then, the reason why we might want for the euro area—for the euro to become a stronger and more popular currency is because it’s going to generate more trade and therefore more wealth.

CHRISTINE LAGARDE: I don’t want to jump to conclusion. I think the observation is that the more trade you have, the more reserve you have. But it’s obvious that the stronger the currency, the easier it is. You know, when you go and visit Vietnam or when you go and try to invest in, you know, whichever country, typically the relationship ends up with how much and then in what currency and who takes the exchange risk. Well, if we have a strong currency, we can negotiate in euro rather than have to go through either the local currency of the country in which you invest or with which you trade or the dollar, which is often referred to as the currency of reference because of its role as an international currency.

MARIA DEMERTZIS: If I may pick on one of the things you said on the—on the depth of the capital markets, I think, as one missing –

CHRISTINE LAGARDE: Yeah.

MARIA DEMERTZIS:—a slight diverging a little bit of the—of the role of the currency, but the creation of the depth of markets in the euro area is something that we have been at it for some time. We have been ten years—

CHRISTINE LAGARDE: Yeah. More than ten years, yeah.

MARIA DEMERTZIS: More than ten years. What, in your view, is the one thing that we need to do next in order to really create the conditions for capital markets to develop and thrive in Europe?

CHRISTINE LAGARDE: Well, what makes the strength of the—of the US capital market is, you know, Treasury bills, Treasury bonds. This is something that we have on a scattered—in a scattered way, not in a unified way. And you know, the only instrument that I can think of which is vaguely similar to that would be the European instrument that are issued by the Commission to finance NextGenerationEU. That is—but that has been defined and agreed as an ad-hoc instrument to deal with the pandemic.

Will we go further than that? It’s not for the central bank to decide. Would it help setting up a strong capital market with depth? Of course it would.

MARIA DEMERTZIS: Thank you for that.

I’m looking at the time. I really want to talk also about one more last thing, the digital euro, this—and the—

CHRISTINE LAGARDE: Oh, we’re here for the rest of the day now.

MARIA DEMERTZIS: Exactly. I mean, first of all, I would like to commend the Atlantic Council because they have produced a wonderful database on where countries and central banks are with regards to digital currencies.

But again, talking about the euro area, I am—especially for the benefit of our audience, I am a bit puzzled why—don’t we already have a digital euro? I only pay—I never pay with cash. I only pay with digital money. What is a central bank digital currency?

CHRISTINE LAGARDE: All right. To keep it super simple, I would say that it’s a digital banknote with a little less anonymity than the paper banknote, OK, because it is issued/guaranteed by the central bank.

Am I saying that banknotes will disappear? Uh-uh. No. And, you know, that’s the beauty of Europe. You are fine paying with your plastic cards, or with your phone, or using whatever token you use. But in other countries, people are still very happy to hold bank notes in their pocket and to pay quite significant purchases with cash.

I happen to be one of those. I like—I like bank notes, I’m sorry. I use plastic cards, and my phone eventually, but yeah, there is an attachment to cash that exists in many countries. If you look from—at the moment, I think there is a referendum in Austria to argue with public opinion support against a directive by the commission to actually require that any payment north of ten thousand euros be made not in cash. Well, the Austrians are not happy with that, as I understand, because they want to be able to use cash. Now, there are multiple reasons why it is legitimate to not have those huge payments in cash, because you want traceability, you want to fight money laundering, you want to fight tax evasion, da, da, da, da, da, da.

But do you know what is the first thing that we found out when we did the first survey and sort of client testing? We found that all those who are interested in a digital euro that would be a central bank-guaranteed payment system, peer-to-peer and otherwise, they say that the one thing that we really care about is privacy.

And privacy, I think, has been—I mean there are countries in Europe which have suffered from lack of privacy, and these countries are particularly attached to their privacy. But second, I think there have been enough scandals in the last few years of companies that have collected data through payments, notably and otherwise, and that have monetized those data by selling databases, by producing artificial intelligence-produced in-depth analysis of you, me, and others. And they don’t want that.

So, you know, I think it’s—in addition to being the sort of central bank-guaranteed digital banknote, it’s also a digital payment that should be available, if people want it. You know, if Europeans don’t want it, then we shouldn’t go there. But we should be ready if they want it, because we provide the guarantee that those data will never be exploited for commercial purposes.

Whether people pay to buy their bread, or they pay to buy their cars, or what kind of medicine they purchase, what kind of frequency they go to a hospital, is none of our business as central banks. It can be the business of private sector data collectors, who happen to find out lots of interesting things about us. This is not the business of a central bank, and it should never be.

MARIA DEMERTZIS: Do you think—and also linking it to the previous question—maybe a digital euro will actually make it more popular outside the EU waters?

CHRISTINE LAGARDE: Could well be, could well be, but for that, and maybe we circle back to the Atlantic Council purpose and the trans-Atlantic relationship, and what the council has always aimed at and for. This has to be coordinated with others. We cannot—you know, a digital currency is borderless. It shouldn’t be borderline, and it should certainly cross the lines, which is why I think it should be regulated and properly supervised.

But it can facilitate cross-border payments, big way, which is why between the United States authorities, the European authorities, and others beyond that, we need to compare notes. We need to check what the imperatives are. We need to understand what is the ideal supervision and regulatory mechanism so that we have something that—you know, systems and currencies in digital form that can talk to each other, even at retail level and certainly more so at wholesale level.

So, I’m so pleased that the Atlantic Council is doing this CBDC tracker and is facilitating a dialogue between the authorities. I think it’s great. We need it.

MARIA DEMERTZIS: Absolutely.

President Lagarde, thank you very much. That’s all we have time for today. Thank you for your very frank and very clear answers, so thank you for taking the time to join us this morning.

Watch the full event

The post Full transcript: Christine Lagarde on fighting inflation, coordinating monetary policy, and creating a digital euro appeared first on Atlantic Council.

But everything has a price. By imposing sanctions and freezing assets in response to Russia’s invasion of Ukraine, the G7 has reawakened a long-simmering debate about dollar alternatives. The idea of “de-dollarization,” or reducing a country’s reliance on the dollar, has gained momentum: From Russia to China—and to many non-aligned countries in between—there is a fear that overreliance on the dollar gives the United States too much leverage.

But what are the realistic alternatives to the dollar that US and allied policymakers should be paying attention to?

How money moves

Let’s start with SWIFT: The Society for Worldwide Interbank Financial Telecommunications is a messaging system that banks use to conduct international transactions. Despite some misconceptions, no actual financial transactions occur on SWIFT: Its value lies in the role it plays in safe, secure, and efficient communication between banks. When it was founded in the 1970s, it connected 239 banks across fifteen countries. Today, it connects over eleven thousand financial institutions in more than two hundred countries and territories, making it the primary mode of communication about international transactions. SWIFT is a private cooperative, owned by two thousand entities; it is headquartered in Brussels and overseen by a group of banks including the US Federal Reserve (Fed), the European Central Bank, and several individual banks in the European Union, in addition to the banks of Japan, England, and Canada. The United States and the European Union, therefore, play a key role in its governance. 

Since SWIFT does not hold any bank accounts, the actual fund clearance and settlement occurs using the Fed-owned Clearing House Interbank Payments System (CHIPS). On average, CHIPS cleared close to $1.8 trillion in transactions daily. The system has forty-three direct participants, which are all US banks or foreign banks with US branches, and eleven thousand indirect participants, which are banks without US branches who are engaged in the system through their accounts with direct participants. Through its participants, CHIPS covers over 96 percent of dollar-denominated cross-border transactions. CHIPS works in parallel with the Fed-owned Fedwire Funds Service to actually clear and settle transactions.

Together, SWIFT, CHIPS, and Fedwire broadly cover almost all dollar-denominated international transactions. They create a network effect that is nearly impossible to rival. How do their alternatives stack up in comparison? 

Today’s challengers: Russia and China

Russia began developing its System for Transfer of Financial Messages (SPFS) after being hit by a round of sanctions following the 2014 annexation of Crimea. It functions as an alternative to SWIFT for transmitting information across four hundred domestic Russian banks and around fifty international entities primarily from Central Asia. Although reports have recently emerged about central banks in India, Iran, and China connecting to SPFS, the system is still primarily a mode for domestic interbank communication in Russia. 

On the other hand, China’s Cross-Border Interbank Payments System (CIPS) is an alternative to the CHIPS system. It was created in 2015 to function as a settlement and clearance mechanism for yuan transactions. Like CHIPS, it is supervised by a central bank (in this case, the People’s Bank of China) and requires direct participants to be within its jurisdiction. Interestingly, participants can message each other through the CIPS messaging system, but 80 percent of transactions on CIPS rely on the SWIFT infrastructure. This is partly a result of the need to translate messages, which is more efficiently done through the SWIFT network. CHIPS has ten times as many participants as CIPS and processes forty times as many transactions as CIPS.

Yuan transactions only amount to 3.2 percent of all transactions using SWIFT. China’s political goals to internationalize its currency, which led to the creation of CIPS, conflict with the capital controls on the yuan, making the yuan less attractive as a currency than the dollar. That doesn’t mean there isn’t interest in expanding the role of CIPS: unverified reports suggest that the volume of transactions through CIPS has grown by 50 percent per year. 

Both CIPS and SPFS offer incomplete alternatives to the powerhouse combination of SWIFT, CHIPS, and Fedwire. These challengers have a smaller network and smaller scope, but most importantly, they do not impact the prevalence of dollar-denominated international transactions. 

Still, it is important to note that they were both created following the imposition of stricter financial sanctions on the countries that designed these systems. As US officials tighten sanctions measures, there will be more incentive for countries to participate and grow the network of these alternative payment rails. This is an important balancing act for sanctions policymakers. 

The idea of getting around the dollar isn’t limited to US adversaries like Russia or competitors like China. Countries like India, Indonesia, Brazil, and South Africa are all exploring changes in the way they process cross-border payments and the possibility of reducing their reliance on the SWIFT system.

Playing a new card

Looped into these payment networks are credit- and debit-card schemes connecting consumers to merchants across the world. Visa, Mastercard, and American Express are the three largest companies that allow cross-border and domestic payments. Visa and Mastercard each reach close to 53 million global merchants in over two hundred countries. Chinese banks in 2002 launched an alternative payment network: UnionPay, which enjoyed a monopoly over China’s domestic markets until 2020, when China began to allow international card schemes. Today, UnionPay connects 55 million merchants in 180 countries, including 37 million merchants located outside of China. 

Since Visa and Mastercard suspended their services in Russia, UnionPay has emerged as one of the only options for cross-border transactions for Russians. Another one of those options is Mir, Russia’s homegrown card scheme. Mir, which was developed during the 2014 round of sanctions on Russia, has become popular because it is used for pension and public-sector payments domestically and can be used by Russians living abroad. Over one hundred million Mir cards have been issued, and several countries, including Turkey and Iran, have expressed interest in joining Mir’s network. Additionally, Russian banks have been doing business with UnionPay for several years, and given UnionPay’s large network, Mir could partner with UnionPay to expand its reach with marketing or even co-branded cards.

A focus on fintech

Increasingly, fintech alternatives to traditional payments are cropping up in the form of wallets and platforms that enable primarily retail payments. AliPay and WeChat Pay, run by Chinese fintech companies, are the two most popular digital wallets globally. AliPay and WeChat Pay each have more than a billion users, while their closest competitors (ApplePay and GooglePay) have around four hundred million to five hundred million users each. While reports differ, some sources say AliPay is in use in up to 110 countries and WeChat Pay is in use in up to fifty countries. The digital wallets are primarily used in domestic payments, and transactions are designated in the local currency of the country. 

Central bank digital currencies (CBDC) have become popular among countries looking for an alternative to the dollar-based financial system because they can be faster, cheaper, and more efficient than the existing cross-border payments rails. According to Atlantic Council research, there are now twelve cross-border CBDC experiments underway. One of the projects, Multiple CBDC Bridge (mBridge), connects Thailand, Hong Kong, China, and the United Arab Emirates in a multi-currency exchange bridge, which offers a cheaper, more efficient, less risky, and faster transaction pipeline than existing systems. Wholesale CBDCs, which are intended for institutional transfers between banks, are a new way in which countries are both solving problems in the payments architecture while creating new networks of payments transfers. These systems, though not yet ready for full launch, could help countries bypass SWIFT and develop an alternative financial architecture. 

Central Bank Digital Currency Tracker

Our flagship Central Bank Digital Currency (CBDC) Tracker takes you inside the rapid evolution of money all over the world. The interactive database now features 130 countries— triple the number of countries we first identified as being active in CBDC development in 2020.

Over time, these innovations could erode the way the dollar’s global dominance is used to make sanctions effective. That’s certainly the hope in Beijing: According to the International Monetary Fund (IMF), the People’s Bank of China has three hundred staff members solely dedicated to its CBDC—that’s larger that the entire staff of most other countries’ central banks. 

How to keep the dollar on top

De-dollarization is not a new idea—but both fintech innovation and the weaponization of the dollar via sanctions have breathed new life into an old debate. Given China’s capital control over yuan transactions and its lack of liquidity, the dollar still reigns as the preferred stable and easily convertible currency for international payments. Transactions done with credit cards or fintech solutions still form a small portion of global foreign exchange flows and are not the main target of sanctions. And given the Fed’s interest rate hikes, the dollar’s value is surging.

But threats to the dollar are looming in the distance: The yuan’s share in global payments has seen an uptick this year, and given the energy crisis, countries could be convinced to offer ruble or yuan swap lines and increase the share of these currencies in their balance sheets. Over time, if the United States does not lead with allies in their own technological innovation, many countries will seek alternatives. There have been some early steps in this direction: Last week, the Biden administration released a slew of reports on digital asset regulations. Some of these reports detailed the possible design for a dollar-based CBDC. But since that may be years away, the Fed is set to test the Fednow Service in 2023, creating a much faster payments system within the United States. 

While the dollar isn’t going anywhere any time soon, it may find it has some unexpected company in the international financial system sooner than it would like. 

What is there to do? US leadership must work to curb the growing fragmentation in the global payments landscape. This can be achieved by clarifying domestic regulations, especially when it comes to the Fed’s authority in issuing digital dollars and the role of dollar-backed stablecoins. The United States cannot lead without a model; and for this, it will have to encourage innovation on CBDCs but also in the form of more efficient private-sector payments options. Finally, the United States has a crucial role in setting global standards and needs to be more active at the Group of Twenty (G20) and IMF on these issues. This would serve two purposes: It would ensure that innovation in the payments landscape does not lead to more fragmentation and also would make clear which countries are interested in collaborating—and which ones truly want to carve out a different path. 

Ananya Kumar is the assistant director for digital currencies at the Atlantic Council’s GeoEconomics Center.

Josh Lipsky is the senior director of the GeoEconomics Center.

The post The dollar has some would-be rivals. Meet the challengers. appeared first on Atlantic Council.

The framework follows US President Joe Biden’s March executive order in which he not only outlined the government’s approach to digital assets, but also asked several government agencies to jot up policy recommendations for the approach, tackling everything from the digital dollar to regulations on cryptocurrency.

We reached out to our experts from the GeoEconomics Center to tell us their top takeaways from the reports and what they mean for the United States’ role in the international financial system—and just how quickly the dollar can go digital.

Catch up on the global race for a CBDC with the GeoEconomics Center’s tracker

Central Bank Digital Currency Tracker

Our flagship Central Bank Digital Currency (CBDC) Tracker takes you inside the rapid evolution of money all over the world. The interactive database now features 130 countries— triple the number of countries we first identified as being active in CBDC development in 2020.

In this order, what’s the case the Biden administration is making for a CBDC?

The Biden administration is saying a digital dollar could provide faster payments and improve the way we all interact with the government and banks. Right now, even though we don’t see it, it can take hours or days for payments to “settle.” There are fees associated with this—ever wonder why a small business owner won’t accept a credit card payment for less than five dollars? A digital dollar could change all that and provide what US Treasury Secretary Janet Yellen has called a “faster, safer, and cheaper” option. But there are lots of questions that need to be answered. How do these digital dollars impact the current financial system? Can they protect your privacy? Are they safe from hackers? That work has been front and center for us at the GeoEconomics Center including our latest report on the topic.

Then there’s the international side; and this is as prominent as the domestic side in the reports, which is really fascinating. The Treasury Department says it wants to talk more with other countries, share knowledge on digital currencies, and help set international standards. Treasury recognizes that it is in the national interest to create a digital dollar and that there are national-security concerns connected to it.

What does that mean? It means that, as China is creating its own digital currency, the United States wants to make sure the model that proliferates around the world is one that respects democratic values—for example, privacy. But in order to do that, the United States needs to bring its own model to the table. Treasury is saying today that the United States is going to do that and that it’s a whole-of-government priority. The issue is urgent. As Atlantic Council research has shown, over one hundred countries representing 95 percent of global gross domestic product (GDP) are exploring a digital currency. Now with the United States stepping up its activity, nearly all of these countries are going to be asking what Washington will come up with and making sure their currencies work with the world’s reserve currency.

Russia plays a role in this too. The reports frequently mention wholesale CBDCs, or how banks transfer money to each other—different than the way we buy coffee. In the wake of Russia’s invasion of Ukraine and the Group of Seven’s (G7) sanctions, many countries are starting to explore ways around the dollar-based international financial transfer system. Digital currency could be an option—and that’s all the more reason that the United States needs to be front and center in these developments and have its own option.

—Josh Lipsky, senior director of the Atlantic Council’s GeoEconomics Center

What are the next steps, and how far away are we from being able to buy coffee with digital dollars?

The United States is far away! The digital euro is scheduled to go online in the middle of the decade and a digital dollar is well behind it. Most likely it will be several years until anyone is using a digital dollar in normal life. The first step is building a model that works—that will help around the world because other countries can learn from the United States and make their currencies work with ours. Then the United States would have to pilot the model—Congress needs to get involved at some point most likely—and then eventually move from pilot to launch. To put things in perspective, China started its work on this around 2016. They are still in the pilot phase, although it’s a big pilot with over 260 million users. So the United States is a long way away, but today is a big step.

—Josh

On cryptocurrency, is this new order a response to the upheaval we’ve been seeing in the markets?

Yes, there’s quite a bit in these reports that is a response to recent hacking and ransomware attacks, and there’s a lot of attention paid to new kinds of illicit-finance risks arising from the broad use of crypto. Around two billion dollars were stolen from crypto hacks this year, which puts added pressure on regulators and crypto companies to find solutions to this issue.

Given that another big news item of the year was the collapse of the stablecoin terraUST and how consumers who had invested heavily lost their savings overnight, a big focus of the reports was also on consumer- and investor-protection standards for digital assets. In the background, of course, there is the “merge,” which refers to the upgrading of Ethereum-based tokens from a less environmentally sustainable mining system (the proof of work consensus) to a more energy-efficient mining protocol (proof of stake). One of the Treasury reports gets into the environmental burdens of mining and, very interestingly, also explores how crypto can help monitor and support climate-mitigation efforts.

—Ananya Kumar, assistant director of digital currencies at the Atlantic Council’s GeoEconomics Center.

What’s the potential impact of new rules on a typical crypto user?

There are going to be many education efforts from agencies in keeping with the consumer protection goals of the administration, so that consumers can be aware of the risks of their purchases and sales. For the average crypto user, there is little immediate impact from these reports, and that’s because even though the reports identify potential policy options for crypto and stablecoin regulation, they do not actually change the regulation status quo domestically. The reports talk at length about how to enhance enforcement capabilities of the agencies, but what the crypto industry needs is clarification regarding which agency is going to be the right forum for their issues—and the reports don’t provide much there.

—Ananya

How is all this likely to be received on Capitol Hill, and what can we expect from Congress now?

Congress is already very active on the issues, and you can expect things will only accelerate from here. There is bipartisan consensus that there should be legislation around stablecoins—making sure things that say they are equivalent to a dollar truly are. But it’s much harder to find agreement on cyrptocurrencies and CBDCs. Most likely, the United States will get some new regulations around cryptocurrencies and stablecoins next year (probably not as strict as these reports would like) and some encouragement for the Federal Reserve’s work on a digital dollar. Congress doesn’t have to decide quite yet whether the Fed can give digital dollars out to Americans, but that decision will come in the near future.

—Josh

The post How long before there’s a digital dollar? appeared first on Atlantic Council.

“WHEN BANKS LEAVE: THE IMPACTS OF DE-RISKING ON THE CARIBBEAN AND STRATEGIES FOR ENSURING FINANCIAL ACCESS”

September 14, 2022

Chairwoman Waters, Ranking Member McHenry, and distinguished members of the Committee, it is my privilege to address you this morning on the impacts of de-risking in the Caribbean and strategies for ensuring financial access. Today, my testimony will focus on (1) why correspondent banking relations matters and how de-risking is an impediment to Caribbean economic development; (2) how de-risking affects U.S. national security and why it matters for U.S.-Caribbean relations; and (3) recommendations that can help address de-risking in the short- and long-term. Today’s testimony draws on the recommendations of the Financial Inclusion Task Force, which was convened by the Caribbean Initiative at the Atlantic Council’s Adrienne Arsht Latin America Center.

First, I congratulate the Committee for prioritizing the withdrawal of correspondent banking relations in the Caribbean. It was an honor to accompany Chairwoman Maxine Waters to Barbados in April 2022 to participate in the Financial Access Roundtable that was co-chaired by the Honourable Mia Mottley, Prime Minister of Barbados in which the issue of de-risking was raised. Given the impacts and challenges facing Caribbean economies, governments, and citizens, urgent action is needed to safeguard the future survival and prosperity of the region. In this vein, addressing de-risking is critical. At the same time, ensuring that the Caribbean remains connected to the global financial system via correspondent banking relations has direct and indirect benefits for U.S. interests and its national security.

Financial development and access are cornerstones of economic growth and development. Critically, correspondent banking and cross-border financial flows are essential for countries, financial institutions, individuals, and businesses to transact and effect payments. These payments are necessary for all countries, particularly for international and domestic trade, foreign investment, portfolio management, and other key cross-border transactions, such as remittances. Simply, correspondent banking is the medium used to access international currencies, including the U.S. dollar. Without access to the global financial system, U.S. interests are adversely affected, as it provides an opening for increased financial crimes, illicit flows, the usage of Chinese currencies, and limits U.S. economic influence abroad.

The need to address de-risking in the Caribbean has never been more urgent. The region’s small and open economies are under threat. Over the past decade, natural disasters and extreme weather events have limited the economic potential in the Caribbean. Over the past two years, the COVID-19 pandemic has taken on this role. Russia’s invasion of Ukraine and the resulting consequences, in the form of rising food and energy prices, has the potential to cripple Caribbean economies and disrupt the livelihoods of the region’s citizens. Correspondent banking is at the core of helping Caribbean countries rebuild after each economic shock. It allows for countries to access development finance from multilateral banks to invest in new, resilient infrastructure and is a medium that allows organizations deliver needed aid to citizens in need.

De-risking and its effect on Caribbean economies

While de-risking occurs globally, the Caribbean is disproportionately affected. A 2015 survey by the World Bank found that the Caribbean, due to its small size and limited financial markets appears to be the world’s most severely affected region. In 2017, a survey from the Caribbean Association of Banks noted that up to twenty-one Caribbean countries lost at least one correspondent banking relationship. And in 2019, a Caribbean Financial Action Task Force survey showed that at least sixteen banks from The Bahamas, Belize, Jamaica, and members of the Organization of Eastern Caribbean States lost access as well.

De-risking in the Caribbean varies from country to country. Of the Caribbean Community (CARICOM) countries, Belize (-51%), Saint Vincent and the Grenadines (-45%), Dominica (-42%), and The Bahamas (-41%) fared the worst by sheer numbers of lost correspondent banking relation counterparties. Specifically, in Belize, over the course of one year, three domestic banks lost 90 percent of their correspondent banking relations. For these countries, the cost of doing business increased across the broader economy, especially for sectors – such as the tourism industry – that are reliant on executing U.S. dollar transactions. Further, since U.S. and European banks were primarily responsible for de-risking banks in Belize, domestic banks had to look elsewhere for correspondent banking relations, specifically turning to services in Turkey and Puerto Rico. One consequence is that this incurred longer processing times for transactions with some operators in key economic sectors unable to receive payments for almost four months.

Importantly, de-risking affects three main drivers of economic growth and recovery in the Caribbean – remittances, travel and tourism, and access to the global financial system. Remittance flows to the Caribbean are critical for supplementing incomes of working-class populations and accessing the U.S. dollar. For Jamaica, remittances contribute a fifth of the country’s overall GDP and for other countries, they account for upwards of at least 5 percent. Correspondent banking relations allow remittance companies, such as money transfer operators, to move currency from one financial institution to another. In the case of the Caribbean, it helps convert the U.S. dollar to localized currencies. De-risking affects this sector by increasing the operational costs of sending and receiving remittances. This becomes a deterrent to send remittances to the region and can provide incentives for relatives to use other, informal means of transferring money abroad.

The tourism industry in the Caribbean is also affected by de-risking. According to the Inter-American Development Bank, ten of the top twenty tourism-dependent economies in the world are CARICOM members. The value of the tourism industry cannot be understated, nor can correspondent banking be for the functioning of the sector. Correspondent banking is essential for credit card settlements. The inability to process transactions via credit or debit cards due to lost banking relations or high costs in accessing to the U.S. dollar can deter tourists. It also means that local hoteliers and restaurants that service tourists are less likely to afford to import products purchased abroad, such as food, pillowcases, bedsheets, among others.

Most importantly, de-risking limits the ability of Caribbean governments, financial institutions, and businesses to access the global financial systems in terms of trade, investment, credit, and financial flows. Most of these economies also run large physical-trade deficits because of their dependence on imported goods, fuel, and food. The result is that these companies are net importers of capital, usually in the form of investment, credit, and remittances. Without correspondent banking, many of the transactions needed to secure these goods and services would not be possible. De-risking leads to high costs to sustain these transactions and can have adverse effects on market functioning. Simply, it would limit banking customers from sending and receiving payments or maintaining relations with foreign suppliers. This can lead to decreases in revenue for businesses, ultimately contributing to defaults on baking loans, which, in turn, weakens the domestic banking system.

Addressing de-risking is critical for U.S. national security and interests

While de-risking has severe impacts in the Caribbean, the United States, its national security, and interests are not spared. Because of the region’s proximity to the U.S. shores and as a logistics hub for the movement of people and goods, what affects Caribbean countries often impacts the United States. There are four main areas where de-risking affects U.S. interests: (1) the U.S. government’s ability to regulate monetary transactions; (2) the effectiveness of U.S. economic influence; (3) the role of the Chinese currency; and (4) the long-term potential rise of political instability and crime.

The U.S. dollar as the world’s most used currency is critical to U.S. influence abroad. For Caribbean countries, it is central to the health and functioning of their economies. And the main mechanism for accessing the U.S. dollar, beyond receiving hard cash during tourist arrivals, are through correspondent banking. De-risking curtails this possibility, and with it, U.S. monetary and regulatory agencies’ ability to monitor transaction activity. Therefore, de-risking is counterproductive to addressing concerns of money laundering in the region if organizations, enterprises, and individuals are forced to use alternative currencies or avenues – a process commonly referred to as shadow banking. These networks can hide criminal and terrorist activities, making it more difficult for U.S. investigative agencies to bring them down. This presents a clear national security risk for the United States due to the Caribbean’s proximity to countries that house illicit actors, such as Venezuela and Cuba. Increased shadow banking via de-risking coupled with limited U.S. regulatory capability due to lost access to the U.S. dollar exposes the Caribbean to becoming a future hub for criminal financing.

Over a 20-year period (1999-2019), the U.S. dollar accounted for an estimated 96 percent of all trade in the Americas, making the currency critical to the U.S.-Caribbean economic relationship. Companies that are seeking to shorten supply chains and nearshore to the Caribbean are likely to face barriers if they cannot pay service and product suppliers in the region. For companies looking to invest in emerging industries, such as the oil and gas markets of Guyana, Trinidad and Tobago, and Suriname, correspondent banking will be vital to ensuring that the U.S. private sector is able to compete for and maintain existing contracts. There are also implications for trade relations. Most owners of micro, small, and medium-sized enterprises purchase goods and services from the United States, specifically Florida. As of 2020, the Caribbean accounts for nearly 40 percent of all of Florida’s trade with Latin America and the Caribbean. An inability to export to the Caribbean can decrease the overall trade balance of the U.S.-Caribbean relationship, forcing countries in the region to source products elsewhere.  

Continued de-risking and loss of access to the U.S. dollar presents an opportunity for Caribbean governments and financial institutions to seek new or strengthen existing relationships abroad, notably with China. While Caribbean governments and people rely on the U.S. dollar, it is not the only internationalized currency. The euro is an alternative, but Caribbean governments face similar de-risking challenges with banks in the European Union. The result is an opportunity for Chinese RMB and its banks to strengthen ties with the Caribbean. Currently, Chinese RMB is not internationally traded to the extent of the U.S. dollar or the euro, nor are Chinese banks as present as U.S. correspondent banks. Chinese RMB also accounts for just 2 percent of global reserves. However, RMB use is increasing globally. From 2009 to 2016, Chinese CBRs globally grew from sixty-five to 2,246. Despite its limited global influence, the RMB still has the potential to be used in smaller markets t, such as the Caribbean. De-risking from U.S. and European banks can push them in this direction. More banking relations offer China new avenues to engage with partners in developing regions that are currently struggling to attract or maintain CBRs, such as Caribbean countries.

The draw of new banks and RMB usage from China is likely to be attractive for most Caribbean countries and can influence Taiwan’s allies in the region. At present, five of Taiwan’s remaining fourteen allies are CARICOM members (Belize, Haiti, Saint Vincent and the Grenadines, Saint Lucia, and St Kitts and Nevis). Except for Haiti, these countries have each lost more than 30 percent of their correspondent banking counterparties since 2011, meaning lost access to the U.S. dollar and potential economic benefits from the United States. China provides an alternative to its allies in the region and if the severity and frequency of de-risking rises in the region, Taiwan’s allies might look to switch diplomatic recognition. These countries, because of their small size, are pragmatic actors, who make decisions in the best interests of the needs of their citizens and their own objectives. Thus, if de-risking continues to threaten Caribbean economic development in Taiwan’s allies, Chinese assistance can be a plug for the holes left by U.S. banks that have de-risked the region.

Since the availability of correspondent banking relations underpins economic growth, the loss of them can drive people into poverty and unemployment as well as limit governments’ ability to respond to the needs of their citizens. This leads to security risks for the Caribbean and broadly for the United States. First, increased poverty and unemployment incentivizes citizens to engage in criminal activity to replace lost household incomes and sustain their livelihoods. Further, it can be a driver for people to join criminal organizations for similar reasons, thus increasing the power of organized crime relative to the state and its own police forces. Second, since de-risking adds another layer of constraint of the fiscal flexibility of Caribbean governments, social unrest and riots might ensue when leaders cannot immediately respond to citizen needs. The likelihood of this increases with frequent disasters and economic shocks – something that is a regular occurrence in the Caribbean. 

Strategies to address de-risking that can strengthen U.S.-Caribbean relations

Never has there been more appetite between the United States and the Caribbean to expand cooperation and strengthen their partnership. This was seen at the Ninth Summit of the Americas, where the United States announced the U.S.-Caribbean Partnership to Address the Climate Crisis 2030, otherwise known as PACC 2030. Further, Vice President Harris, on several occasions, and President Joe Biden at the Summit, has carved out time to meet with Caribbean leaders and listen to their perspectives and viewpoints on matters of shared interests, such as food and energy security and access to development finance. In fact, the Congressional Delegation led by Chairwoman Waters to Barbados in April of this year and this hearing to address de-risking in the Caribbean are added indications that U.S.-Caribbean relations are headed in the right direction.

It is important now to take these words and turn them into legislative action. Addressing de-risking can be a first, tangible step as correspondent banking is the lifeblood of economic activity in the Caribbean. In many ways, it is one of the most important avenues of U.S.-Caribbean relations, enabling U.S. government agencies to provide disaster assistance after natural disasters, allowing the U.S. private sector to invest in the region, and ensuring the trade relations with Caribbean countries remain strong.

Earlier this year, the Caribbean Initiative at the Atlantic Council’s Adrienne Arsht Latin America Center released a report, “Financial De-risking in the Caribbean: U.S. Implications and What Needs to be Done,” of which the foreword was written by Chairwoman Waters. The report was a result of an almost year-long process, where the Initiative’s Financial Inclusion Task Force – a group made up of bankers, regulators, and multilateral representatives from across the United States and the Caribbean – met to provide recommendations on how U.S. policymakers can best curb de-risking.

Based on the findings of the report, there are several actions U.S. legislators can take to support Caribbean economic development and protect U.S. interests by addressing de-risking. Since correspondent banking is integral to a functional and healthy global economy, this Committee should consider putting forward legislation that categorizes it as critical market infrastructure or a public good. Through the U.S. Congress, this determination would provide justification for the U.S. Government and international financial institutions to incorporate access to correspondent banking as part of aid and development packages.

Key to the process of addressing de-risking in the Caribbean is ensuring that the affected actors are part of the overall discussion. Caribbean financial institutions and governments have first-hand accounts of the unique challenges they face to address the causes of de-risking and are therefore in the best position to provide feedback on which strategies are most effective. This Committee should consider, through legislation, working with the U.S. Treasury to consult with affected Caribbean actors when developing solutions that lead to greater financial access for the region.

Working hand-in-hand with the Caribbean financial institutions and governments also means providing them with a platform that shows progress these actors have made to fulfill compliance and regulatory requirements. As such, the Committee should consider adopting and passing “The INCSR Improvement Act,” which will help Caribbean financial actors and government leaders annually underscore actions taken to address money laundering, drug trafficking, and financial crimes. The passage of the Act will help promote healthy dialogue between U.S. and Caribbean actors.

Dialogue is critical to addressing de-risking. Therefore, the Atlantic Council is working alongside and in coordination with several key partners to create an annual U.S.-Caribbean Banking Forum. The intent for the Forum’s creation stems from the Atlantic Council’s report on financial de-risking and was supported by Caribbean government leaders and U.S. legislators during the April 2022 Financial Access Roundtable in Barbados. Since then, an organizing committee that comprises bankers, multilateral representatives from across the Americas, and the Atlantic Council has been formed to carry out the inaugural Forum and will look to include the recommendations and feedback from this hearing into its eventual agenda.

In sum, the health and future of U.S.-Caribbean relations may well depend on correspondent banking relations remaining present in the region. Caribbean countries face an uphill battle to address de-risking. Even some of their solutions to note such as launching a Central Bank Digital Currency (CBDC) to address de-risking comes with its challenges. An Atlantic Council tracker on CBDCs notes that cybersecurity is an increasing concern as well as the ability of countries to house these currencies where there is instability in the financial system – two areas where Caribbean countries are still in need of support.

Decisive action is needed for U.S. interests and national security, yes, but also for the prosperity and livelihoods of the average U.S. and Caribbean citizen. Thank you, once again, for the honor and the opportunity to appear before the Committee today. I look forward to answering your questions.

Staff

Wazim Mowla

Associate Director, Caribbean Initiative

Adrienne Arsht Latin America Center

Caribbean China

Related content

Report Mar 1, 2022

Financial de-risking in the Caribbean: The US implications and what needs to be done

By Jason Marczak, Wazim Mowla

This report identifies how the withdrawal of correspondent banking relations, otherwise known as de-risking, affects Caribbean economies, people, and US-Caribbean relations.

Americas Caribbean

Sep 23, 2020

Caribbean Initiative

The Adrienne Arsht Latin America Center’s Caribbean Initiative began programming in February 2021 to raise awareness about key Caribbean Community (CARICOM) priorities with US and global stakeholders while deepening US engagement with the region around shared interests. The Initiative is a platform for US and Caribbean stakeholders to offer new and innovative insights to benefit a closer US-Caribbean partnership and the overall prosperity, stability, and well-being of the region.

Testimony Jan 19, 2022

Marczak testifies to the House Committee on Foreign Affairs on the new Alliance for Democratic Development

By Jason Marczak

Adrienne Arsht Latin America Center Senior Director Jason Marczak testifies to the House Committee on Foreign Affairs regarding the new Alliance for Democratic Development.

Caribbean Economy & Business

The Adrienne Arsht Latin America Center broadens understanding of regional transformations and delivers constructive, results-oriented solutions to inform how the public and private sectors can advance hemispheric prosperity.

Explore more

The post The Atlantic Council’s Wazim Mowla Provides Testimony at US House Financial Services Committee Hearing on Caribbean Financial Inclusion appeared first on Atlantic Council.

Russia remains an inescapable focus, though not entirely for predictable reasons. The busiest sanctioning entity this summer has been Russia itself. The country does, of course, remain the prime target of Western sanctions. For more on that, take a look at our brand-new Russia Sanctions Database, which tracks Western sanctions against Russian entities and individuals—and highlights where gaps still remain.

Iran: US designations continue as nuclear negotiations wind up

The United States and Iran are negotiating a deal that would lift harsh sanctions on Iran in exchange for a major rollback of Iran’s recent nuclear advances. The next few weeks will be critical. On September 14, US President Joe Biden’s Iran envoy will report to Congress on the progress of negotiations. Iran has made new demands that the US has rejected and it is by no means certain that an agreement will be reached before US midterm elections. While Iran’s nuclear activities are key, another important factor is the West’s desire to secure new sources of energy as Russia and Saudi Arabia have agreed to slow down oil production.

Opponents of the deal argue that, if sanctions are lifted, Tehran would have additional sources of income to spend on proxy groups in the Middle East and that restrictions on Iran’s stockpile of enriched uranium would expire in 2031. Another concern is that Iran, once freed from energy sanctions, could make oil swap deals with Russia and allow Moscow to circumvent energy sanctions. Specifically, Russia could gain a backdoor route to sell its oil by supplying crude to northern Iran via the Caspian Sea, while Iran would sell equivalent amounts of crude on Russia’s behalf in Iranian tankers. This would undermine Western energy sanctions against Russia by allowing Moscow to profit from oil revenues through Iran. The argument is far-fetched in our view. Technical difficulties aside, Iran would make more money by selling its own hydrocarbons than by serving as a transit point for Russia. Supporters of the deal have consistently argued that this is the best and only way to curb Iran’s rapidly accelerating nuclear weapons program. 

In the meantime, until any deal is reached, the United States will keep sanctioning Iranian petrochemical companies and persons engaging in transactions with them. Most recently, the US Treasury Department designated companies used by Iran’s Persian Gulf Petrochemical Industry to facilitate sales of Iranian oil in East Asia. Treasury has also sanctioned international front companies and shipping companies facilitating oil transactions for Iranian companies. The United States re-applied broad sanctions on Iran when it left the Joint Comprehensive Plan of Action (JCPOA) in March 2018. The United States often designates new companies on the basis of new intelligence and US officials are likely to increase pressure if a deal remains elusive.

Sanctions certainly have damaged important sectors of Iran’s economy. The heavily sanctioned Iranian aircraft and cargo fleet is becoming more dilapidated day by day. More than 170 planes are grounded while more than 50 percent of passenger planes cannot fly because of a lack of engines and spare parts. The National Iranian Tanker Company, which owns the world’s largest fleet of super tankers, is also unable to modernize its vessels due to sanctions. The 2015 nuclear deal allowed some updates and repairs to take place, but these stopped in 2018. 

Spotlight Russia: Number one imposer and target of sanctions this summer

Looking at the visual below, one thing should stand out: The country that imposed the highest number of sanctions this summer was Russia. Moscow maintains an autonomous sanctions regime and also complies with the United Nations Security Council’s sanctions. This summer, the Russian intelligence agency Rosfinmonitoring (RFM)—also known as the Federal Financial Monitoring Service and reports directly to the president of Russia—added 752 entities and individuals to its terrorists and extremists list. 

One of the entities recently added to RFM’s sanctions list is the Adat People’s Movement, which was previously added to the Russian Ministry of Justice’s banned entities list based on the Supreme Court of Chechnya’s decision in 2022. The movement, which does some of its work on the active 1ADAT Telegram channel, stands for an end to the “occupation” of Chechnya. The court decision and consequent listing by the Ministry of Justice already meant that the Public Association Adat People’s Movement was slated for liquidation. Adding the Adat People’s Movement to the RFM’s list may appear to be unnecessary duplication, but the listing could be used in the future against individuals associated with the movement. The RFM designation could also apply to a grouping which avoids taking on any form of legal identity. Crucially, RFM designations do not require an official court decision, unlike new designations to the Ministry of Justice’s list of banned entities. 

In addition to becoming the number one sanctioning country, Russia also remained the number one sanctioned country. The European Union’s (EU) seventh package of sanctions targeted Russia’s top lender, Sberbank, freezing its assets in the West and blocking transactions that are not food- and fertilizer-related. 

On September 5, Russia cut gas exports to Europe by ceasing all deliveries through the Nord Stream 1 pipeline, citing the need for turbine repairs. Germany exposed itself to heavy criticism when it secured a sanctions exemption in June to send a turbine repaired in Canada back into Russia. At the time, Berlin argued that sending the power compressor turbine (which is needed for the pipeline to function) would call Russia’s bluff and make clear that deliveries were being curtailed for purely political reasons. This is ultimately what has happened only three days after the Group of Seven (G7) countries announced they would force a price cap on Russian oil exports.

Drug trafficking sanctions: Are they effective?

Turning to Latin America, Mexico and Colombia have a high number of sanctioned entities and individuals. The primary reason is their involvement in the illegal drug trade, covered by US Executive Order 14059, as well as Narcotics Trafficking and Foreign Narcotics Kingpin Sanctions Regulations. 

This summer, the US Treasury designated Obed Christian Sepulveda Portillo, an individual acting on behalf of the Mexico-based Cartel de Jalisco Nueva Generacion (CJNG)—a violent organization responsible for trafficking fentanyl and other deadly drugs to the United States. Portillo was trafficking firearms from the United States to CJNG, enabling the cartel to protect drug trafficking routes and other illicit assets. Treasury has previously sanctioned CJNP and its network of businesses and individuals facilitating the illegal drug trade. As a result of sanctions, any property or interests owned by Portillo in the United States will be blocked and reported to Treasury, and Americans will be prohibited from facilitating transactions with him.

By restricting access to US financial institutions, sanctions against drug trafficking organizations and individuals disrupt their operations. However, it is unclear whether sanctions alone can deter potential traffickers. Treasury has been keen to highlight that its designations have helped dismantle cartels and apprehend leaders; but it also acknowledges that these outcomes were achieved in coordination with US and foreign law enforcement agencies. Taking on the cartels does cause collateral damage locally: Unemployment and drug-trafficking violence tend to increase as new groups compete for abandoned territory. Still, there are merits to deploying sanctions to tackle the illegal drug trade, and it is reassuring to see that policies are subject to internal scrutiny and frequent evaluation. 

Russia is the main driver behind this year’s designation uptick

This year has been one of the most intense in the history of sanctions, driven by the West’s resolute and united response to Russia’s invasion of Ukraine. Still, given that the United States has the most expansive sanctions program, partners have been catching up. Switzerland increased its total number of sanctions by 66 percent from last year, followed by the United Kingdom’s 56 percent. 

To learn about Western sanctions against Russia and to find out where gaps still remain, check out our brand-new Russia Sanctions Database.

On the radar

1. EU foreign policy chief Josep Borrell delivered a downbeat assessment of the prospects of reviving the JCPOA on September 5, noting that the US and Iranian positions were “diverging.” However, this divergence is mainly to do with nuclear safeguards, not with new sanctions designations by the United States.
2. Fears of a winter crisis in Europe have heightened speculation that EU sanctions against Russia may be lifted. Recently we have seen well-attended protests in Prague calling for sanctions to be lifted, frequent comments by France’s opposition parties disparaging “counterproductive” sanctions, and even some calls for the Nord Stream 2 pipeline from Russia to Germany to be opened. Some voices in Germany still assume the technical difficulties befalling Nord Stream 1 are real.
3. The EU member most strongly threatening to break from the bloc’s sanctions consensus is Hungary. Ahead of a routine European Council vote on sanctions renewal on September 15, Budapest threatened to wield its veto unless three Russian businessmen were removed from the asset freeze and travel ban list. It has since dropped this demand. Though frequent, Hungary’s demands for exemptions and amendments do not threaten the overall architecture of the EU sanctions regime.
4. We remain strongly of the view that the EU will maintain sanctions pressure on Russia. EU members are already pushing back against speculation that it would lighten the pressure, arguing that export controls take time to be properly effective. Through the G7, the EU has also signed on to the US price cap initiative despite skepticism in Brussels and Paris about its technical feasibility.

Global Sanctions Dashboard

The Global Sanctions Dashboard provides a global overview of various sanctions regimes and lists. Each month you will find an update on the most recent listings and delistings and insights into the motivations behind them.

Explore Here

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Global Sanctions Dashboard: Sanctioning soars across the board appeared first on Atlantic Council.

Instead, the August 26 accord may mark the beginning of a new normal in which the biggest Chinese corporations decamp from Wall Street to Hong Kong while new Chinese listings in New York slow to a trickle. 

The agreement targeted Beijing’s refusal to allow US access to the paperwork of the accounting firms that audit listed Chinese companies. Such inspections are mandated by US law and accepted by all other governments whose companies list on Wall Street. Under last week’s agreement, the paperwork is to be made available to US inspectors in Hong Kong. Without that solution, Beijing was facing the mandatory delisting of Chinese companies in 2024. But the agreement does not mean the issue has been fully resolved. Securities and Exchange Commission (SEC) Chairman Gary Gensler has stated several times—including in the announcement of the accord—that “the proof will be in the pudding.”

Only China’s compliance with the terms of the agreement will forestall a worst-case scenario: the mass delisting of more than 250 Chinese companies.

Either way, it appears to be the end of an era in which many Chinese companies enjoyed largely unfettered access to US equity markets while US investors were able to broaden their exposure to what, until recently, was the world’s most dynamic economy. It will also add to the forces steadily driving the US and Chinese economies apart.

Cease and delist

The process of separating corporate China from Wall Street began during the Trump administration, when US regulators ordered the delisting of three Chinese telecommunications companies as part of an effort to restrict investments in companies deemed threatening to US national security. Delisting gathered momentum earlier this month as five Chinese state-owned enterprises—including three of the world’s largest energy companies—announced that they would leave US markets. The move signaled that China was prepared to reach the audit agreement, although it didn’t want to give the United States access to the books of important state companies.

But the pressure has also come from inside China. A crackdown on alleged violations of corporate governance that began in late 2020, which has only eased in recent months, hit some of China’s most successful corporations, particularly e-commerce companies. These include Nasdaq-listed Alibaba Group, Tencent Holdings (traded over-the-counter in New York), and the ride-hailing company Didi Chuxing Technology Co., which Beijing forced to delist from the New York Stock Exchange right after its June 2021 initial public offering (IPO). Didi was accused of ignoring government concerns about cybersecurity issues.

The crackdown has been codified in various regulations and laws, most recently the Cybersecurity Law implemented in February, which introduced the strict regulation of cross-border business and financial market activities. It specifically mandates a review by Chinese government officials of all data controlled by internet companies with more than one million users before an overseas listing can proceed.

When combined with the damage from widespread COVID-19 lockdowns in major Chinese cities and a spreading crisis in China’s property sector, the pressure on the tech sector caused a sharp economic downturn this year. That, in turn, hit China’s financial markets and added to the disenchantment of American investors with Chinese stocks. Companies listed on the Nasdaq exchange, for example, saw their share prices plummet by more than 60 percent from all-time highs in February 2021 as the audit dispute and concerns about the negative news from China took hold. 

Ironically, China’s economic and financial-markets performance probably gave Chinese regulators more leverage in Beijing as they negotiated the audit agreement with the United States. Losing access to a source of capital in New York clearly appeared more daunting than when China was riding high. The added shock of failed talks would have been another self-inflicted wound for Beijing’s beleaguered policymakers. Thus the undoubtedly bitter decision to agree to the SEC’s demands.

A haven in Hong Kong?

Some observers predict the audit agreement—the terms of which are mostly undisclosed—may contain the seeds of its own failure. For example, analysis of the two governments’ announcements of the accord suggest differing interpretations of its key point about how much autonomy the US Public Company Accounting Oversight Board (PCAOB), which is responsible for auditing listed companies’ financial statements, enjoys in its inspections. Goldman Sachs says the market is pricing in a probability of “around 50 percent” that Chinese companies will be delisted, down from 95 percent earlier this year.

Small wonder, then, that several large Chinese companies, led by Alibaba and online retailer JD.com, are establishing dual primary listings in Hong Kong. That action would facilitate smooth delisting from Wall Street should that eventuality occur—and for the first time enable Chinese retail investors to buy those stocks via trading links with the Chinese mainland. 

It also would fit with the long-term strategy of the Chinese government to use the Hong Kong Stock Exchange as an alternative venue for overseas listings. China’s media already has taken to calling the Hong Kong listings a “golden parachute” for Chinese companies listed on Wall Street.

If China’s cybersecurity watchdog decides that the vast troves of data held by companies like Alibaba are too sensitive (even if PCAOB bookkeepers can’t access them), then some of those companies are expected to leave New York and move to Hong Kong. That’s why it’s noteworthy that Morgan Stanley last year started tracking the performance of several Chinese internet stocks in Hong Kong—instead of New York—in calculating its market indices, a move that led several US institutional investors to shift their holdings of those shares away from the US markets.

Meanwhile, there has been only one IPO of Chinese stocks on Wall Street this year valued above one billion dollars. By comparison, there have been five on mainland Chinese exchanges, which have seen a record $58 billion of IPOs this year despite the overall weak market performance. The most recent Chinese IPO in the United States raised about $25 million.

For the moment, retaining a foothold on Wall Street remains Beijing’s immediate priority as it seeks to head off a deeper economic downturn. But in the long run, its interest lies in boosting the global standing of China’s financial markets—and that portends a continued loosening of the market ties that once were expected to inextricably bind the US and Chinese economies.

Jeremy Mark is a senior fellow with the Atlantic Council‘s Geoeconomics Center. He previously worked for the International Monetary Fund and the Asian Wall Street Journal. Follow him on Twitter: @JedMark888.

The post Deal or no deal, Chinese firms will still ditch Wall Street appeared first on Atlantic Council.

China’s decision to delist these companies is motivated by its unwillingness to comply with US regulations; they make up five of the eight NYSE-listed, national, state-owned enterprises (SOE) for which China has resisted sharing auditing review data with the US Public Company Accounting Oversight Board (PCAOB) on ground of national security.

While the practical implications of the five companies delisting are limited, many analysts view China’s willingness to delist rather than comply with US reporting requirements as consistent with China trying to become more economically and financially self-reliant. This assessment exaggerates the financial implications of delisting, which need to be put in a broader perspective instead.

Generally speaking, the number of Chinese ADRs traded on US stock exchanges is small, on average about 10% of the number of shares traded in China or Hong Kong. Consequently, the liquidity impact of delisting for those five companies is minimal. Furthermore, international—including US—investors can still invest and trade in those companies’ shares in China and/or Hong Kong, so that those companies retain access to international capital. 

As well, looking forward, the delisting prospects for the additional three hundred or so companies based in China or Hong Kong (together with a market capitalization of $2.4 trillion) remain uncertain. Two decades of negotiations between the United States and China to allow PCAOB access to auditing review documents of those companies drag on. Chinese companies will face a delisting deadline in 2024 according to the Holding Foreign Companies Act of 2020. Assuming that all US listed companies based in China and Hong Kong will delist, the United States will lose a small fraction of their $2.4 trillion of market capitalization. The loss is negligible compared to the $48.2 trillion combined market cap of US stock exchanges.

More importantly, the delisting of Chinese companies from US stock exchanges does not indicate that China wants to isolate itself from world financial markets. It more likely highlights the trend of the world dividing into two economic and financial spheres, and abiding by increasingly differentiated rules, regulations, and standards.

China has actually taken several measures to liberalize inward capital movements, mainly by establishing the Bond Connect (2017) and Stock Connect (2014) programs to facilitate international investors taking positions and trading in domestic Chinese stock and bond markets. These programs have been expanded to include swap contracts and exchange traded funds (ETFs) to offer greater choice to investors. Derivative contracts are scheduled to open to international investors. China has also improved the working of its qualified institutional investor programs. Consequently, the amount of domestic Chinese financial assets owned by foreign investors has increased substantially from $459 billion in 2016 to $1.2 trillion in 2020. More specifically, foreign holding of Chinese domestic bonds has risen to RMB 3.6 trillion ($531 billion) as of June 2022. Likewise, foreign holding of Chinese companies’ A-shares listed domestically and H-shares listed in Hong Kong stood at RMB 1.5 trillion ($221 billion) and HKD 2.1 trillion ($268 billion)—for a total of $488 billion—at the end of 2021.

In short, China wants to attract and benefit from international capital flows, but only to its domestic financial markets within its jurisdiction—and not under US laws. Whether China succeeds in that ambition depends less on where Chinese shares are listed, and more on China’s economic and corporate profit growth outlook for the years ahead. Still, the delisting saga illustrates the growing division of the world into two different and competing economic and financial spheres—already visible in the semiconductor and telecommunication sectors. “One world, two systems” is fast becoming a reality.

Hung Tran is a nonresident senior fellow at the Atlantic Council GeoEconomics Center; former executive managing director at the Institute of International Finance and former deputy director at the International Monetary Fund.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Delisting Chinese companies from the New York Stock Exchange: Signs of decoupling appeared first on Atlantic Council.

Reforming the international corporate tax system was always going to be a complicated process despite the clear need to prevent a race to the bottom on corporate tax rates; policy and political inertia has kept the current apparatus in place for nearly a century. After decades of the status quo, governments and businesses are analyzing final tax design and administration details. For example, which tax credits and deductions should be exempted under the new tax, and how would these decisions impact domestic tax codes?  

Aside from policy questions, there has also been substantial political pressure against a global minimum corporate tax. Some businesses have lobbied against the tax, and countries have been hesitant to implement the tax first out of fear that if other nations don’t quickly follow, their businesses will be disadvantaged. In the United States a global minimum corporate tax was not included in the Inflation Reduction Act (IRA) for this reason. The IRA did enact a fifteen percent minimum corporate tax on accounting book income; however, this tax is different in several ways and does not adhere to the global agreement. Notably, the IRA minimum tax does not calculate taxable income on a country-by-country basis.

The European Union (EU), another leader in forming the agreement, has also struggled to move forward with implementation. Procedural rules make it difficult to enact the tax on an EU-wide level without unanimous support from the bloc’s twenty-seven members. Twenty six members have currently signed off, but Hungry is opposing it.

Considering these challenges, the OECD announced that the formal rules will not be completed until 2023. Implementation will not occur until late 2023 or 2024. The rules were supposed to be finished by mid-2022. Concerns are mounting that countries are going to lose interest, no country will go first, and a moment of promise to reform the international corporate tax system will prove fleeting.

However, while the path forward does not look easy, this is unlikely to be the end of a global minimum corporate tax. The Organization for Economic Cooperation and Development (OECD) led negotiations have made progress on final implementation rules for central components of the agreement, such as the “undertaxed profits rule.” If a multinational corporation (MNC) profitably operates in a country without a minimum corporate tax rate of fifteen percent, the rule allows participating countries to “top up” the company’s tax rate. This enforcement mechanism creates strong financial incentives for non-participating countries with MNCs to join the agreement and collect new corporate tax revenue.

For example, assume Country A has a corporate tax rate of twenty five percent, Country B has a rate of ten percent, and Country C has a rate of nine percent. The global minimum tax rate is fifteen percent. Company X operates in Country A, reports income in Country B, and is headquartered in Country C. Country A would “top-up” the taxes paid on Company X’s reported profits in Country B by five percent (the global minimum of 15 percent minus Country B’s rate of 10 percent) and collect additional tax revenue. The agreement enables Country A as a participating country to do this because Company X’s home country, Country C, is not participating in the agreement and does not top up the tax rate on Company X’s income in Country B.

The key to this rule is that a critical mass of countries where MNCs operate must implement the agreement. Once a major economy imposes the tax and starts collecting additional revenues, other countries are more likely to follow suit. MNCs in non-participating countries would be paying more taxes either way, and countries will want to keep the revenue their MNCs are sending elsewhere. When the first domino falls, a chain reaction ensues.

The EU could act as that first domino. While the EU has not yet implemented the tax, twenty six of its twenty seven members want to and they represent most of the bloc’s economy (the third largest in the world). If Hungry does not agree, members may individually change their tax codes via domestic legislation or adjust procedural rules such that unanimous support is not required for EU-wide implementation. Ratification by the EU would be an enormous step forward and alleviate concerns about who goes first. Other allies, such as Canada and Japan, are also in the process of actively trying to move the tax forward

At times it seemed like the United States was going to be the leader in forming this agreement and implementing it. That is no longer the case, but the United States could still join at a later point. If other OECD economies and allies implement the tax, the United States would be motivated to do so because it would lose out on billions of dollars in corporate tax revenue a year and create complexity for its MNCs by having multiple international tax regimes for them to comply with. Additionally, after the IRA, the United States will now have even more experience with a minimum corporate tax. The administrative infrastructure would merely need to be adjusted, not transformed.

It was a pleasant surprise when the global minimum corporate tax agreement happened last year given the difficulty of major tax reform. Implementation has not been smooth thus far, but there is enough alignment between financial incentives and diplomatic will that another pleasant surprise is likely in store.

Jeff Goldstein is a contributor to the Atlantic Council’s GeoEconomics Center. During the Obama administration he served as the Deputy Chief of Staff and Special Assistant to the Chairman of the White House Council of Economic Advisers. He also worked at the Peterson Institute for International Economics. Views and opinions expressed are strictly his own.

Further reading

New Atlanticist Apr 7, 2021

The case for a global minimum corporate tax

By Jeff Goldstein

As policymakers around the world consider a global minimum corporate tax, it is important to understand the context behind the concept and how this tax might actually work.

Economy & Business Financial Regulation

Blog Post Oct 8, 2021

US climate investments are required to secure green economy and jobs

By Jeff Goldstein

For the US economy to sustainably function and continue creating jobs in the long-term, investments that help manage climate change and prevent further damage to the environment are essential economic policies.

Climate Change & Climate Action Economy & Business

The post Delayed but not defeated: The road ahead for a global minimum corporate tax appeared first on Atlantic Council.

The post Mark quoted in Politico China Watcher newsletter on bipartisan support for delisting Chinese firms from US markets appeared first on Atlantic Council.

On central bank digital currencies

The European Central Bank has done something novel—it explained to the public why it is interested in a CBDC. If and when it does issue a digital euro, the outreach will pay dividends.

This speech by Agustín Carsten is one of the best in recent memory on the potential impact of a CBDC and on the fundamentals of trust that fuels all fiat currency.

Our CBDC tracker captures the global development of CBDCs for over 100 countries. It is a living document that is updated periodically as developments arise. 

On stablecoins

This year, the stablecoin markets saw immense volatility, market crashes and an industry wide reckoning to go back to the basics—what is a stablecoin, and how exactly is it stable?

I find this blog post by Neha Narula at the Massachusetts Institute of Technology’s’s Digital Currency Initiative very illuminating on the technology choices available to stablecoin issuers and how it all comes together. 

“On the Economic Design of Stablecoins” by Christian Catalini and Alonso de Gortari is an early look at the risks pertaining to stablecoins, and it evaluates how risky a stablecoin is based on the reference assets underlying the algorithm. 

We saw Catalini and Gortari’s predictions play out this year as TerraUSD and Luna—two algorithmic “stable”coins issued by Terra—dramatically lost their peg to the dollar. Coindesk provides a detailed timeline of the team and vision behind Terra and the days leading up to its collapse.

On the crypto crash

Terra’s collapse triggered the crypto crash this summer—as the market capitalization of the industry fell 70 percent. What happened, and how are industry, consumers and regulators responding to the crash? 

Want to understand the crash? Here’s an explainer on the broad market trends leading up to the crash. 

As tokens crashed, companies liquidated and exchanges halted trade, individual investors lost billions, sometimes overnight, in crypto markets. Sirin Kale wrote a feature on these investors for The Guardian.

On regulation

The crypto crash created an urgency for regulation to protect consumers and investor interests. These principles were laid out earlier this year in President Biden’s Executive Order on digital assets. Here’s our explainer on it. 

On the US side, there’s quite a bit of debate about how to classify digital assets and which agencies will have regulatory jurisdiction over them. Gilad Edelman for WIRED explains these developments. 

Meanwhile, the European Union (EU) passed the Markets in Crypto-Assets law, which had been under deliberation for a while, partly due to its clause on how mining impacts the environment. Here is the EU’s perspective on the proof of work clause.  

On national security

As the US Treasury Department’s Office of Foreign Assets Control (OFAC) designates cryptocurrency entities such as Tornado Cash, SUEX, and others, all eyes are on the financial crime and sanctions evasion potential of cryptocurrencies. 

Cryptocurrency analysis group Elliptic published its annual report on financial crime in crypto. The report describes the different types of mal-actors in the crypto ecosystem and the techniques they use to get money into and out of tokens and exchanges.

Jason Bartlett at CNAS published a report on a group of North Korean hackers, the Lazarus Group, who were behind more than $600 million in leakages across different exchanges in 2018-2020. 

And on the future:

What does the future of crypto and Web 3.0 look like? A look at some innovative applications of DLTs, and the opportunities and challenges they might produce. 

In a first of its kind use-case in the public sector, a Chinese bank issued loans using China’s CBDC, the e-CNY. Loans appear in e-CNY denominations in users’ wallets and can be repaid using the wallet as well. More details on this will be forthcoming, but this is a novel crossover of DeFi lending protocols into the public sector. 

As cities like Miami, Austin, and New York begin to offer their own city-based tokenized offerings, Adam Willems for WIRED looks at these CityCoins, and whether they could reshape tax laws in the United States. 

I really enjoyed this piece on game developers in the crypto industry. It is an interesting meditation on the existing tensions between art and science, as well as new and old modalities of labor and work culture. 

Here’s an old piece on the flourishing crypto channels in Lebanon, a country affected by continuing economic crises. It is a touching look at how humans adapt technology in times of adversity. 

Are you a beginner looking to understand the world of crypto, CBDCs, stablecoins and more? Sara Harrison’s A Normie’s Guide to becoming a Crypto Person and the New York Times series The Latecomer’s Guide to Crypto are where you should start.

Ananya Kumar is the Assistant Director for Digital Currencies with the GeoEconomics Center.

Related reading

Dec 14, 2021

Central Bank Digital Currency Tracker

Our flagship Central Bank Digital Currency (CBDC) Tracker takes you inside the rapid evolution of money all over the world. The interactive database now features 130 countries— triple the number of countries we first identified as being active in CBDC development in 2020.

Report Jun 15, 2022

Missing Key: The challenge of cybersecurity and central bank digital currency

By Giulia Fanti, Kari Kostiainen, William Howlett, Josh Lipsky, Ole Moehr, John Paul Schnapper-Casteras, and Josephine Wolff

New research on the cybersecurity challenges posed by digital currencies and design models that can provide a more secure financial system.

Cybersecurity Digital Currencies

Econographics Mar 1, 2022

A Report Card on China’s Central Bank Digital Currency: the e-CNY

By Ananya Kumar

China’s CBDC, the e-CNY debuted at the world stage during the Olympic Games. Here’s what we know so far.

China Cybersecurity

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Summer reading list: Future of money edition appeared first on Atlantic Council.

It is the third country in the region, after Sri Lanka and Pakistan, that knocked on the door of the IMF in recent months. While the economic crises in Pakistan and Sri Lanka were widely reported in international media, Bangladesh’s situation flew under the radar for quite some time thanks to the government’s repeated denial of any impending crisis. Bangladeshi Prime Minister Sheikh Hasina’s government—for years—touted the economic success of the country and recently celebrated the opening of Bangladesh’s largest bridge as a symbol of its self-reliance. 

The government claims that its request for “budget support,” an unrestricted loan with low interest which allows it to use the money as it wishes, is a preemptive measure and that the economy is not, in fact, in trouble. 

This could not be further from the truth.

Huge financial woes

Dhaka’s search for financial support is not limited to the IMF. Besides requesting from the World Bank a one billion dollar loan, an estimated $2.5-3 billion have been solicited from several multilateral agencies and donor nations (such as the Japan International Cooperation Agency, or JICA) just this year.

Furthermore, considering that ongoing austerity measures including power cuts, restricted use of foreign currency, and fuel rationing are yet to make any major dent in the crisis, the government’s claim—that the country will weather shrinking foreign exchange reserves, a growing trade deficit, record inflation, daily depreciation of the local currency, and an intense energy crisis—is doubtful. As the IMF and other multilateral agencies open their purses to Bangladesh, it is also imperative to understand how the country arrived here.

The journey can tell us where the solution lies 

Dhaka would like everyone to believe that the economic slowdown from the COVID-19 pandemic and the global impact of the Ukraine-Russia war are to be blamed for its current plight, but this only tells part of the story. The following statistics paint a far more worrisome picture:

• Bangladesh received at least $1.7 billion in loans from multilateral agencies by June 2020, and by October 2021 it had borrowed at least three billion dollars from development partners as budget support to combat the adverse impacts of the pandemic. 
• It is reported that budget support received from various multilateral agencies between 2019-2020 and 2021-2022 amounted to $5.8 billion. 
• Dhaka received $732 million from the IMF as a balance of payment support and $1.4 billion from the World Bank to implement the countrywide vaccination program. 
• It obtained sixty-one million doses of COVID-19 vaccines from the United States, free of cost. 
• The government also offered various stimulus packages and repeatedly claimed that its economy not only turned around, but was on the road to a dramatic recovery, with such optimism echoed by the World Bank. 

This information reveals two things—that the fallout from the pandemic should have been addressed in the past year with significant support from external sources, and that the government has been taking loans in recent years despite claims of robust economic growth. 

What, then, prompted Bangladesh’s economic and financial crisis?

External factors notwithstanding, four domestic areas tied to government policies can be identified as sources of the present crisis: 

• High cost of infrastructure projects, often described as “mega projects”
• Crisis in the banking sector due to widespread default of loans 
• Waste of resources in the energy sector 
• Capital flight 

Unsustainable infrastructure spending
Since coming to power in 2009, the Hasina government has undertaken several large infrastructure projects funded by various countries and multilateral agencies. These projects include the Padma Bridge, a nuclear power plant in Rooppur, Dhaka City Metro Rail, and Karnaphuli Tunnel, to name a few. Padma Bridge, one of the largest projects in the country, cost about $3.6 billion, which was previously estimated to be $1.16 billion in 2007. The ambitious nuclear power plant is costing Bangladesh $12.65 billion, and the actual amount to be spent will not be known until it is commissioned. The Metro Rail project ballooned to $3.3 billion from its original estimate of $2.1 billion. The cost of the underwater Karnaphuli Tunnel reached $1.03 billion, though originally estimated at $803 million. 

Unfortunately, these are not exceptions, but patterns. In 2017, the World Bank noted that the cost of road construction in Bangladesh was the highest in the world. The cost overrun is largely because of overpricing of materials, corruption, and long delays. 

Loan defaults and banking malpractice
In addition, the banking sector, which has been in the news for quite some time, is crippled by large scams and non-performing loans. In 2019, when the Central Bank claimed that the total amount of defaulted loans was $11.11 billion, the IMF disputed this, saying that the true amount is more than double. The current official figure has been questioned by many on several grounds, however. 

There is an explanation for this discrepancy—bad loans can be easily manipulated and hidden through write offs and changing the official definition of “bad loans” to skirt regulations. 

In simple words, the Central Bank is alleged to have “cooked the books,” both in hopes of providing a rosy but inaccurate picture, as well as to benefit the incumbent and her inner circle. Corruption watchdog Transparency International Bangladesh said that “immense political pressure and illegal intervention by some large business groups” are the causes of an unabated increase in loan defaults. 

This is not a new phenomenon, and though experts have been warning of such a situation for years, the Central Bank has not taken effective steps, instead changing policies to help the loan defaulters.

Corruption in the power sector
In March 2022, the government celebrated its success in extending electricity coverage to the entire country. This, however, came at a high price. 

The associated increase in electricity generation was largely due to the establishment of Quick Rental Power Plants (QRPPs) in the private sector. In 2009, it was said that these units were stopgap measures until a comprehensive, long-term solution was found. Increasingly, though, these units have become the mainstay of electricity generation, and not without suspicious beneficiaries. 

In the past decade, the power sector received huge subsidies—between 2010 and 2021, the Power Development Board received $7.1 billion, while the Bangladesh Petroleum Corporation received three billion dollars between 2010 and 2015. Notably, this occurred while the prices of electricity and fuel hiked for consumers. Furthermore, the capacity charge provisions included in the contracts with Independent Power Producers, Rental Power Plants, and QRPPs force the government to pay these companies even when they did not provide any electricity. 

These units are owned by companies connected to the government who are milking the system to their benefit. In the past decade, twelve companies received $5.5 billion as capacity charges. Additionally, the government has signed agreements with Indian energy company Adani which would require Bangladesh to pay annually $423.29 million and $11.01 billion over its lifetime of twenty-five years as capacity for its energy supply.

Capital flight
In the past decade, as rampant corruption allowed a small group of people to amass large sums of money, Bangladesh witnessed widespread money laundering according to watchdog Global Financial Integrity. Between 2009 and 2018, annually $8.27 billion was siphoned through mis-invoicing of the values of import-export goods. The growth of deposits by Bangladeshis in Swiss banks in the past decade is indicative of capital flight. In 2021, it increased by 55.1 percent, reaching 871 million Francs ($912 million).

In conclusion

While these factors have contributed immensely to the unprecedented crisis Bangladesh is facing, I am neither suggesting that there are no other reasons, nor implying that they are mutually exclusive. Instead, these areas are intrinsically connected to the incumbent’s development policies and ideology. Therefore, Bangladesh’s pathway to the current economic crisis—leading to its arrival at the doorstep of the IMF—did not result solely from the pandemic and the Ukraine crisis. Instead, it was paved by the economic policies of the Hasina government and an unaccountable system of governance of the past decade. 

Two consecutive fraudulent national elections, held in 2014 and 2018, have created a de facto one party system with no checks and balances. As international lenders such as the IMF negotiate more loans for the current government, donors should understand that throwing more money at Dhaka will not bring an end to the crisis. 

A bailout will only act as a bandaid. It may stop the bleeding for the moment, but there is no guarantee that it will magically solve the crisis without reforming an economic system tied deeply to the regime’s self-interested political vision.

Dr. Ali Riaz is a non-resident senior fellow with the Atlantic Council’s South Asia Center.

The South Asia Center serves as the Atlantic Council’s focal point for work on the region as well as relations between these countries, neighboring regions, Europe, and the United States.

Learn more

Related content

SouthAsiaSource Jul 6, 2022

Myanmar’s ‘Rohingya Genocide’: A conversation with Ronan Lee

By Atlantic Council

An interview between Rudabeh Shahid and Ronan Lee to discuss the difficulties in conducting the study and current book ban in Myanmar, post-coup Rohingya conditions, and wider repercussions for the South Asian region.

Bangladesh Civil Society

SouthAsiaSource May 12, 2022

Rising sea levels and the climate crisis in Bangladesh, the Maldives, and Sri Lanka

By South Asia Center

The South Asia Center brings together a panel of experts to discuss the effects of climate change on the economy, food and energy security, and migration in Bangladesh, the Maldives, and Sri Lanka.

Bangladesh Climate Change & Climate Action

SouthAsiaSource Feb 15, 2022

Revitalizing Pakistan-Bangladesh trade cooperation in pursuit of a free trade agreement

By Nida Gulzar

The expansion of cooperation and economic exchanges between Pakistan and Bangladesh is attainable if stakeholders from both sides work together.

Bangladesh Economy & Business

The post Bangladesh’s economic crisis: How did we get here? appeared first on Atlantic Council.

What are US lawmakers trying to achieve by discussing whether or not some 150 Chinese companies listed on US exchanges should be delisted? Is their goal US-Chinese financial decoupling? While discussions about Chinese listings in the US are technically about accounting rules, they should be understood in the broader geopolitical context.

One of the key questions for the future world order is how Western capital markets will be connected to Chinese capital markets. The level of integration between the Chinese and Western capital markets affects China’s economic growth. The greater the links, the better Chinese growth prospects.

If China continues to gain increased access to Western capital China may soon be in a better economic position to challenge the Western liberal capitalist model. However, increased Chinese-Western capital market integration is just one scenario, dependent upon many political and geopolitical factors. Instead of the increased integration we’re witnessing now, ”strong decoupling” or “muddling through” may prove more likely, depending upon the changing perceptions of China and the Chinese financial markets in the US and the West.

For several decades, key Wall Street institutions successfully worked towards US-Chinese financial integration and opening China’s markets. The January 2020 US-China Phase One Deal was a highlight for American banks, which gained the ability to become controlling owners of Chinese financial institutions. US private equity and venture capital has long been actively investing in China. Notwithstanding recent lockdowns and geopolitical uncertainty, Western banks continue to expand their presence in China.

Crucially, since 2016, there has been a significant increase in US and European investors in China’s public markets for stocks, bonds, and derivatives. This flow of Western institutional investment capital into China took off after stock and bond index providers like MSCI, FTSE Russell, and Bloomberg-Barclays decided to include mainland Chinese assets in their indices. Their decision lead to the inflow of hundreds of billions of additional dollars from the US and Europe into Chinese stocks and bonds. In the summer of 2021, Western holdings of Chinese financial assets reportedly amounted to 1.1 trillion US dollars. In early July 2022, Chinese authorities announced “swap connect,” allowing international investors to access China’s €3.1 trillion swaps market.

However, geopolitical tensions, or “strategic competition”  between Washington and Beijing may well stand in the way of further US-Chinese financial integration. US policy makers increasingly perceive that national security is about economic security, which makes international finance a key part of geopolitical dynamics. Thus, institutional investors, as well as international banking and private equity and venture capital are becoming increasingly tied up in US national security affairs.

This trend was marked by the Trump Administration’s expansion of the Committee on Foreign Investments in the United States (CFIUS) with the Foreign Investment Risk Review Modernization Act or FIRRMA, which significantly limited Chinese investment into the US. Concerned about US businesses assisting China’s military-technological rise, the Biden Administration may soon supplement FIRRMA with new legislation to screen outbound foreign direct investment.

Beyond the private markets, there is an emerging pattern of US-Chinese competition for dominance in global banking and potential conflict in the banking markets. As a further indication of US-Chinese tensions in the banking markets, US banks in China have very recently begun to publicly voice differences of opinion with China’s financial authorities.

Regarding portfolio investment in China, both the Trump and the Biden Administrations issued executive orders to prevent US capital investment in the Chinese military-industrial complex. In the Biden White House’s still cautious language, this “signals that the Administration will not hesitate to prevent US capital from flowing into the People’s Republic of China’s (PRC) defense and related materiel sector, including companies that support the PRC’s military, intelligence, and other security research and development programs; or into Chinese companies that develop or use Chinese surveillance technology to facilitate repression or serious human rights abuse.” Considering the significant overlap between the military, security, and civilian components of the Chinese economy, a wide range of Western portfolio investments in China may ultimately become subject to outflow restrictions.

The debate now  is whether, and to what extent, US institutional investors should be barred from holding Chinese financial assets. In the financial industry, there are those strongly in favor of deepening US-Chinese capital market integration. The asset manager Blackrock has called for a further tripling of Western capital flows into China. Similarly, Bridgewater’s Ray Dalio argued that China is on a path forward and highly investable, notwithstanding unavoidable risks. Voices in favor of expanding US-Chinese financial integration seem less concerned with the geopolitical consequences of their investments in China.

On the other hand, several influential voices opine that portfolio investments in China are bad for US national security. In late 2021, the US-Chinese Economic and Security Review Commission (USCC) pointed out that Western portfolio inflows into China’s stock and bond markets undermine US national security in several ways. First, Western money is used to directly fund Chinese military and national security companies. Second, outside investments can flow into Chinese conglomerates which encompass both military and civilian parts. Third, apparently civilian companies still contribute to Chinese military and security technology through China’s military-civil fusion programs, as well as through business ecosystems which facilitate financial and technological know-how, as well as other transfers between civilian and military business. Fourth, Western investments in China’s stock and bond markets make China richer overall and thus allow the CCP to expand its military budget.

It is likely that geopolitical motives will trump business instincts. The overall US relationship with China is dominated by strategic considerations, and finance is increasing seen as an integral part of the equation.

One can only speculate about the consequences as the US moves to further separate American and Chinese capital markets. The structure of international capital markets may become bifurcated, with one centered on China, and one centered on the US dollar. A partial financial decoupling with the effect of trillions being sucked out of, or locked up in, China at once, may cause global contagion and financial instability. How China will react or whether it will seek to deter any US financial decoupling remain relevant questions.

To prevent Western institutional investors from entering the Chinese market, the US will also have to ensure that portfolio investors from Europe will end their exposure to China. This could cause a Transatlantic imbroglio, which will be discussed in a subsequent piece.

As the official US stance on portfolio investments in China is still evolving, international policy makers, market participants, and observers should correspondingly adjust. The most important thing all three groups can do now is to carefully observe the US debate on geopolitical competition with China and be aware that this debate is likely to affect the future of both China’s capital markets and the structure of global finance. Most important of all, this era of financial geopolitics requires that international financial institutions learn to take national security into account at every turn.

Dr. Elmar Hellendoorn is a nonresident senior fellow with the GeoEconomics Center and the Europe Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

Econographics Aug 3, 2022

Trading geopolitics: The US-Chinese capital markets

By Elmar Hellendoorn

Increased Chinese-Western capital market integration is just one scenario. Instead, ”strong decoupling” or “muddling through” may prove more likely.

China Economy & Business

Blog Post Jan 28, 2022

China’s capital markets in the shadow of the CCP

By Elmar Hellendoorn

Under Chinese President Xi Jinping Chinese capital markers have become increasingly politicized as politics increasingly influence Chinese businesses. This politicization may have significant implications for those investing in Chinese financial assets.

China Economy & Business

Issue Brief Sep 14, 2022

Sand in the silicon: Designing an outbound investment controls mechanism

By Sarah Bauerle Danzman and Emily Kilcrease

The stakes for rethinking the investment relationship between the United States and China are high. An outbound investment mechanism must be narrowly targeted, clearly defined, non-duplicative of existing tools, scoped proportionately to administrative capacity, and paired with meaningful multilateral engagement with allies and partners. 

China Economy & Business

The post Trading geopolitics: The US-Chinese capital markets appeared first on Atlantic Council.

The portents of disaster were on display during the recent turmoil in Sri Lanka, where epic government mismanagement sent the country into a thirty-five-billion-dollar debt default amid severe food-and-fuel shortages. While Sri Lanka waits for China, Japan, and commercial lenders—which together represent two-thirds of the country’s debt—to restructure its loans, markets worry that other low- and middle-income countries soon won’t be able to meet their obligations either.

The human cost is becoming all too clear: The rapid rise of food and fuel prices, along with those of other key commodities, is taking a toll upon the most world’s most vulnerable, as several United Nations agencies have highlighted in recent weeks. Hunger is growing and millions are at risk of falling into extreme poverty.

Worse still, the international community doesn’t seem prepared to do much about it.

When they met last week in Indonesia, for instance, the Group of Twenty (G20) finance ministers failed to even to issue a communiqué. With Russian officials participating, divisions within the group over the invasion of Ukraine were at the heart of the discord. At a challenging moment for the global economy, international cooperation was absent from the negotiations.

To get ahead of emerging market defaults, it’s essential that governments focus on devising a road map for debt restructuring that ends the pattern of delaying negotiations by two key creditors—China and commercial lenders—and ensures that there is adequate money to help debtors to fund essential services before restructuring agreements are in place.

A limited debt-crisis toolbox 

The advanced economies’ policy of battling the pandemic with loose monetary policy and increased spending has run its course in the face of the supply disruptions and commodity inflation that followed the Ukraine invasion. As a result, central bank tightening in response to inflation in the United States and Europe is causing an exodus of capital from developing countries. The Institute of International Finance calculates that net capital outflows from emerging-market stocks and bonds over the past four months have totaled $20.7 billion—a figure that likely understates the full extent of the capital flight. It’s a trend likely to continue as interest rates continue to rise and investors seek safer harbors.

As a result, countries and companies are watching their bills soar, especially for those whose debts are affected by changes in interest rates. The International Monetary Fund (IMF) estimates that 30 percent of emerging market countries and 60 percent of low-income countries already are in or nearing debt distress.

Capital outflows have a pernicious impact on balance sheets. First, countries need to replace that money by borrowing offshore at higher rates, which only becomes more expensive as more investors leave. Second, the soaring dollar, currently at a twenty-year high, hits sovereign and corporate borrowers by increasing interest and principal repayments in local currency terms. Corporate borrowers with inadequately hedged dollar exposure could suffer the consequences, as happened to many companies during the 1997-98 Asian financial crisis. Rating agency S&P Global warned this month that “[a]s rates increase, we think currency risk will feature more into… the ability and willingness of companies to fund in U.S. dollars and into distressed situations.”

The problem is that the principal vehicles for global cooperation—the Group of Seven (G7) and G20, along with the IMF—have limited tools to deal with a global debt crisis. This difficulty has only become more complex as global economic power has shifted over the past two decades from the West toward China. Similarly, the role of bondholders and other commercial lenders has increased in importance since the 2008 global financial crisis.

The international community has struggled to devise a comprehensive mechanism to deal with sovereign defaults. But the COVID-19 crisis—which hit the poorest developing countries hardest—forced the G20 to jury-rig a combination of a debt-service moratorium (which ended last year) and a restructuring process called the Common Framework, which is built around “creditor committees” of government lenders.

But that process has been exceedingly slow to get off the ground in the first three countries to seek restructuring—Chad, Ethiopia, and Zambia—in large part because Beijing is resistant to debt reductions (as opposed to delayed payments). 

Private-sector lenders have done little to contribute to a solution to the debt problem since the pandemic hit. Despite holding a large proportion of developing-country debt, they refused to join the debt-service moratorium and often oppose debt reduction. In Chad, for example, the giant Swiss commodities trader Glencore, which holds over one-half of the country’s debt, has refused to agree to a debt reduction.

Delays in the debt-restructuring process are costly for the affected countries: The IMF requires creditors to provide “financing assurances” of debt restructuring or refinancing in order to proceed with its own loans. When it was just G7 governments hammering out deals through the Paris Club of sovereign lenders, the process often could be completed in weeks; now it’s taking months—resulting in deeper pain among those most exposed to the human impact of a default, as has occurred in Sri Lanka. Ironically, Beijing was rebuffed by the IMF when it called for a Zambia lending program to proceed before a debt agreement had been reached.

A stumbling block in Beijing

To its credit, the international community has taken steps to free up resources to assist countries facing severe economic difficulties. Last year, the IMF approved the issuance of $650 billion in reserve assets to member countries, with wealthy countries slowly starting to make their shares of the issuance available to poorer nations. But even a process as unwieldy—and so far ineffective—as the G20 Common Framework is only available to the poorest countries. There is no systematic path forward for emerging-market countries like Sri Lanka and others that may yet default. 

The key stumbling block is China, which—despite its professed commitment to international standards—is likely to remain resistant to international rules that affect its massive exposure as a sovereign lender. There have been recent examples of effective debt workouts for middle-income countries: Ecuador in 2020, for instance, and Suriname last year. The lessons of those two restructurings, which involved Chinese loans, need to be closely examined. Otherwise, more countries like Sri Lanka will be left without recourse. 

One immediate need is to consider a return to temporary suspension of interest payments—for both poor and middle-income countries—to give countries breathing room, and to introduce some form of bridge financing if financial assurances to the IMF are not forthcoming in a timely fashion. The “chair’s summary” issued at the conclusion of the finance ministers in Indonesia meeting (in lieu of the absent communiqué) makes clear that the debt issues received attention. But there appears to be little political stamina to take on these weighty issues. 

With interest rates and inflation soaring and the winds of crisis building across the globe, world leaders soon will have little choice but to return to these issues in order to avoid a catastrophe.

Vasuki Shastry, formerly with the IMF, Monetary Authority of Singapore, and Standard Chartered Bank, is the author of “Has Asia Lost It? Dynamic Past, Turbulent Future.” Follow him on Twitter: @vshastry.

Jeremy Mark is a senior fellow with the Atlantic Council’s Geoeconomics Center. He previously worked for the IMF and the Asian Wall Street Journal. Follow him on Twitter: @JedMark888.

The post The world isn’t ready for the looming emerging-market debt crisis appeared first on Atlantic Council.

The post Lichfield, Fishman, and O’Toole cited in Energy Post on the pros and cons of a price cap on Russian oil appeared first on Atlantic Council.

This week’s main development has been Russia’s (predictable) failure to meet small dollar-denominated interest payments. The Ministry of Finance had skillfully avoided defaulting in April but, this time, the expiration of the US Treasury exemption for the servicing of foreign debt simply meant that Western institutions could not process payments to bondholders.

In this summer edition of the Global Sanctions Dashboard, we will delve into both of these developments. But that’s not all. As the US Government starts to pick up on small Chinese firms “backfilling” for embargoed Western goods, we consider the likelihood of secondary sanctions imposed against China. We also look at the trends in designations of individuals and firms and check out sanctions on illicit actors in the Middle East. 

Russia’s default on sovereign debt

Back in April, some were surprised that Russia avoided defaulting on its sovereign debt. However, this week’s outcome was something of a foregone conclusion. Little over a month later Russia failed to deliver about $100 million in interest on two bonds, the grace period for these payments expired–pushing Russia into default. The reason Russia has been unable to meet these payments is not a lack of funds. On May 25th, the US Treasury Department’s formal exemption allowing US banks to process sovereign debt payments on Russia’s behalf expired. 

Moscow is refusing to acknowledge the default, claiming that it has at least attempted to make the payments. In fact, Russia transferred the money to a clearing house in Belgium, where the assets got frozen because the clearing house cannot settle any securities subject to sanctions. What will happen to these funds is unclear. Ultimately, bondholders are likely to recuperate some of the original principal, possibly in a different currency. The funds are unlikely to be reallocated to Ukraine’s reconstruction. 

The default does not have significant implications for the Russian or the world economy. The US rationale in making this inevitable was that degrading Russia’s veneer of financial respectability would spook potential investors and business partners in non-aligned markets. Russia is already cut off from capital markets and cannot raise money in global financial markets due to sanctions, which is why the default will have little to no influence on the Russian economy in the short term. In the longer term, Russia’s attempts to meet some of future repayments will continue to be thwarted until the US Treasury decides to introduce another exemption. However, given the recent G7 statements and introduction of additional restrictions on Russian gold imports, the US and allies are unlikely to ease up on Russia as long as Moscow continues its brutal war against Ukraine. 

Energy sanctions against Russia

The EU’s partial ban on Russian oil is a more consequential development. It took a while to get agreed on and still has to be formally ratified. The ban is expected to cut 90 percent of Russian (mostly seaborne) oil imports by the end of the year, leaving the 10 percent exemption for the Southern Druzhba pipeline. 

For the rest of the year, the EU and G7 partners will be focused on solving the puzzle of keeping the oil outflow from Russia while reducing the revenue inflow to Moscow. The GeoEconomics Center called on three experts (two policymakers and one markets analyst) for their takes on the pros and cons of the price cap under discussion at the G7 this week.

To avoid a unilateral US approach via secondary sanctions, one prominent idea is to cap the global price of Russian oil via insurance markets. However, it remains to be seen whether the US Treasury and G7 partners can come up with effective enforcement mechanisms and avoid more market distortions and higher oil prices. 

In addition to the oil ban, the US and allies have also maintained sanctions and export controls against Russian oil and gas companies, although the US is far ahead of its allies in this respect. 

Remarkably, the US Treasury and Commerce departments both impose restrictions on Russian energy companies. The US Treasury designates them under the Sectoral Sanctions Identification (SSI) and Specially Designated Nationals And Blocked Persons List (SDN). Meanwhile, the Commerce Department’s Bureau of Industry and Security maintains the Entity List. The primary difference between the two designations is that the BIS Entity List restricts the flow of physical products to designated companies while OFAC designations can include financial as well as export restrictions.

Thus, in response to Putin’s attempt at a fully-fledged invasion of Ukraine, the US Treasury has targeted every aspect of Russia’s economy, from finance, to trade, to key industries like energy and metals, while the Commerce Department has been busy curbing exports to Russian tech, shipbuilding, and aircraft manufacturing companies. 

Irrespective of sanctions, most foreign companies are leaving Russia

In addition to complying with government-imposed Russia sanctions, numerous private companies have chosen to “sanction” themselves by suspending operations or withdrawing from the Russian market altogether. For example, BP exited the Russian market and took a $25 billion hit after writing down its 20 percent share in government-owned Rosneft. Similarly, Shell’s withdrawal from its involvement in all Russian hydrocarbons has cost the company around $5 billion. Regardless of the costs associated with leaving the Russian market, Western companies prefer eating the costs now rather than staying in the market and facing significant reputational and sanctions compliance risks. Given that the US and allies have not given signs of slowing down with Russia sanctions, we don’t anticipate any wave of reinvestment by Western companies any time soon. 

The threat of secondary sanctions against China

Washington has picked up its warnings against Beijing about the potential consequences of undermining US sanctions against Russia, the likelihood of imposing secondary sanctions against China is now at an all-time high. Secondary sanctions are an effective instrument with the potential to deeply hurt the Chinese economy, as Chinese supply chains are not fully insulated. However, the US could also experience some blowback from its own secondary sanctions by undermining relationships with European allies, who fear their firms may be affected.

As you will see in the chart below, the fact is that the US already does sanction Chinese entities and individuals, including companies advancing China’s military-industrial complex. However, secondary sanctions would be much more destructive than existing primary sanctions. 

Secondary sanctions would pressure companies, banks, and individuals to stop engaging with sanctioned Chinese entities, or lose access to US financial institutions. Given that China is highly dependent on third party providers for technological production, it has been approaching the secondary sanctions threat carefully. Some Chinese companies have even moved away from transactions with Russia. For example, UnionPay, China’s credit card processor, refused to transact with Russian banks after Visa and MasterCard stopped serving them. Moreover, China has reduced its exports to Russia. China’s approach is understandable, as the country is highly dependent on foreign suppliers for semiconductors and civilian airplanes production components. Although Beijing is working towards insulating its economy against Western sanctions, in the short to medium term, it is likely to avoid undermining US sanctions. 

Sanctions deceleration

Russia’s invasion of Ukraine has resulted in the harshest ever package of sanctions imposed on any other country of its size, with February and March seeing the sharpest escalation of sanctions. However, more recently, as Western jurisdictions have been observing which types of sanctions and punitive measures have been effective in thwarting Russia’s war chest, the occurrence of new listings has declined across all Western sanctioning jurisdictions. The Russia-driven sudden uptick in sanctions in response to Ukraine’s invasion is likely to remain a one-time precedent, with new Russia designations becoming less frequent but more targeted.

Middle Eastern illicit networks

Aside from Russia, the Middle East stands out as the region most targeted by recent US sanctions, with designations hitting actors ranging from ISIS members in Syria to oil smuggling networks in Lebanon. In Syria, the US targeted five individuals for their role in facilitating the transportation of extremists and conducting financial transactions in support of recruitment of foreign fighters by ISIS. The Treasury also targeted an international oil smuggling and money laundering network that facilitated the sale of Iranian oil in order to support Hezbollah in Lebanon and the Islamic Revolutionary Guard Corps-Qods Force (IRGC-QF) in Iran. In both cases, the Treasury is restricting all transactions of US persons with the designated entities and individuals. Moreover, US institutions might become subject to sanctions if they facilitate transactions for designated entities and individuals, which is likely to be effective in preventing illicit networks from moving money through US financial institutions. 

In the proverbial pipeline

Western sanctions have succeeded in causing Russia to default on its sovereign debt and isolated Russia from the global economy, but the cost has been high. Uncertainty over supply has sent energy prices flying. Figuring out how to minimize the blowback on Western economies will be a priority for G7 partners after their meeting in Bavaria. We will see whether the US Treasury, which is actively promoting the price cap idea, will succeed in getting the EU on board to enforce it. In the meantime, China is likely to do enough to avoid US secondary sanctions, even if that requires moving away from transactions with Russia and reducing the volume of its exports. Finally, sanctions on illicit networks in the Middle East are likely to be successful in cutting their access to finance, hopefully slowing down the pace of their transactions and operations.  

Research Support from: Carrie Hsu

Global Sanctions Dashboard

The Global Sanctions Dashboard provides a global overview of various sanctions regimes and lists. Each month you will find an update on the most recent listings and delistings and insights into the motivations behind them.

Explore Here

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Global Sanctions Dashboard: Russia default and China secondary sanctions appeared first on Atlantic Council.

Around the world, governments used significant deficit spending to help their economies weather the COVID-19 storm. In EMs, the average public debt to GDP ratio just prior to the pandemic was 52 percent. In 2021 it increased to 67 percent, a historic high. This follows a decade long upward trend following the 2008 financial crisis. EM debt could more quickly spill over into domestic economic activity due to the large “sovereign-bank nexus” which characterizes many EMs. Their banks extended credit under government-backed stimuli. If EM governments face growing financial pressure and the public debt banks hold loses value, banks may be forced to freeze credit in dramatic fashion.

EMs currently face multiple pressure points. First among them the increase in global inflation, which caused central bankers in AEs to set higher interest rates. When AE central banks raise interest rates, EMs usually face capital outflows, higher borrowing costs, and currency fluctuations that impact their terms of trade. This time round, the JPMorgan EMBI Global Diversified EMs sovereign bonds index recently suffered its worst loss in nearly 30 years. 

At the same time, Russia’s invasion of Ukraine has exacerbated pandemic supply chain disruptions and significantly increased commodity prices for EMs. EM food and energy prices, especially when imported, have skyrocketed. The rising prices for key inputs, higher borrowing costs, and continued fallout from the pandemic is leading to extremely difficult situations for EMs. Sri Lanka defaulted on its debt last month and more countries could easily follow suit. For example, Pakistan is currently negotiating with the IMF for assistance in managing its debt burden. A growing percentage of EMs are considered “distressed” — defined as potentially unable to fulfill financial obligations on present terms.

Economic and financial instability in EMs would have major negative impacts, none more so than for these countries’ people. Divergent pandemic recoveries mean that most EMs’ income growth was less than America the past few years, for the first time in nearly four decades. EMs are likely facing even worse conditions ahead; more poverty, greater food insecurity, and even slower growth that could lead to a “lost decade” of worsening living standards. According to the World Bank “the level of per capita income in developing economies this year will be nearly five percent below its pre-pandemic trend” and the forecast for the next several years has been revised down.

Aside from the moral necessity of addressing these issues, the entire global community has an economic interest in doing so. Financial and economic crises in EMs would create another meaningful headwind given financial and trade linkages. EMs (including China) represent  around 45 percent of both global Foreign Direct Investment and trade, as well as about 35 to 45 percent of global GDP.

In addition, the opportunity cost of EMs forgoing climate spending, to instead service debt, is not a high-return proposition. EMs are projected to emit an increasing share of global emissions and are already struggling to make investments in sustainable development in wake of the pandemic. There is evidence that the latest debt developments are further limiting some EMs climate change investments. Notably, AEs have also not fulfilled their obligations in pledged climate finance assistance. Moving forward, AEs and multilateral institutions must help in multiple ways.

First, in certain situations, EMs should be encouraged to use capital controls — policy steps to curb the flow of foreign capital in and out of an economy. The international economics community has long frowned upon capital controls, believing they were inefficient. While free flowing global capital does have many economic benefits, research has shown the merit of smoothing out capital flow volatility depending on the country and macro environment. Capital controls can help prevent a surge of inflows from creating financial bubbles. They can also help manage “sudden stops” when foreign investors swiftly reverse course. For example, in the current context, temporary restrictions on capital outflows that are triggered based on preset crisis conditions could help prevent a downward financial system spiral and benefit most stakeholders. The IMF recently updated its Institutional View, although some suggest it should approve of capital controls even more broadly. Nonetheless, this evolution has come at the right time and should be a component of how some EMs manage the challenges ahead.

Second, mechanisms for debt restructuring must be enacted. At the onset of the pandemic official bilateral debt payments were frozen for certain countries, but they have since resumed. A new freeze for a broader set of countries should be instituted. The G20 framework for debt resolution also needs strengthening, most importantly by engaging private creditors and gaining clarity from Chinese State-Owned Enterprises on their lending terms extended to EMs.

Lastly, multilateral institutions should once again provide EMs in need with funding as they did earlier in the pandemic. Some have criticized the amount of support given to EMs during the pandemic as too little. To ensure effective support, member countries must leave no doubt and provide sufficient resources and leeway to help backstop a potentially large wave of distressed EMs.

One of the essential lessons of the COVID-19 pandemic is that countries are interconnected. EMs’ debt management is no different. Residents of EMs and other economies all over the world will be impacted by how this process plays out — now and later. Policymakers would do well to heed this important lesson and act boldly as they work with EMs to help maintain economic stability.

Jeff Goldstein is a contributor to the Atlantic Council’s GeoEconomics Center. During the Obama administration he served as the Deputy Chief of Staff and Special Assistant to the Chairman of the White House Council of Economic Advisers. He also worked at the Peterson Institute for International Economics. Views and opinions expressed are strictly his own.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

Further reading

Econographics Jun 17, 2022

The Fed has regained the initiative, but at a cost

By Hung Tran

The Fed may well have been right in taking forceful actions now to fight inflation after failing to control it, but such actions add to the challenges experienced by economies around the world.

Economy & Business Financial Regulation

New Atlanticist Jun 24, 2022

Seven trends to watch as the world’s richest countries get together

By the GeoEconomics Center

From inflation to sanctions, these are the key questions facing the G7 countries—which represent around half the global economy—at their upcoming summit.

Digital Currencies Economic Sanctions

Econographics May 25, 2022

A new type of global recession

By Josh Lipsky

For the first time, it’s China’s pronounced slowdown which could be the single largest factor in creating a global recession.

Americas China

The post Trouble for Emerging Markets could spell trouble for all appeared first on Atlantic Council.

But more importantly, the G7 has finally flexed its muscles after watching its relevance being called into question for a decade. Now that it has brought down a heavy financial hammer against Russian President Vladimir Putin following his invasion of Ukraine, the question facing the leaders of this group—which represents around half the global economy—will be: What do they do next?

Our GeoEconomics team brings you seven data points they’ll be thinking about as they search for a path forward.

1. Core consumer price index

The leaders of the G7 economies meet precisely as their independent central bankers are beginning to take ownership of inflation. The bankers are raising interest rates with some dread: Most have spent the past eighteen months arguing that inflation is mainly being driven by supply-side shocks—the kind monetary policy is meant to ignore. Now, high energy prices and constraints on Chinese growth have led policymakers to increase the odds of a global recession. Record-high inflation in the eurozone, the United States, and the United Kingdom will feed expectations of further price increases, and central banks recognize they need to intervene to break the cycle.

Coordination is the purpose of the G7. While rates will be hiked at slightly different intervals, leaders can discuss the fiscal side. All are tempted to support households that are facing higher bills, but the countries are coming out of the pandemic with higher debt burdens. Fiscally conservative members, such as Germany and the United Kingdom, will also argue that profligate spending will cause inflation to last longer. 

Will the rate hikes do enough? They are significant for economies that have become used to cheap credit over the past decade. And while the eurozone has seen negative interest rates for about that long, with inflation this high—over 8 percent in the United States and the eurozone— it’s unclear whether rates between 1.5 and 2 percent will alter expectations. 

—Charles Lichfield is the deputy director of the Atlantic Council’s GeoEconomics Center.

2. GDP revisions

G7 economic growth has slowed by more than 2 percent compared to projections from last year. With the group now collectively forecasted to grow around 3.25 percent in 2022, a range of factors—particularly Russia’s invasion of Ukraine—are responsible for the slowdown. But even before the war, the advanced-economy recovery was in a precarious place: Inflation throughout the G7 was already rising due to imbalances in supply and demand, and exacerbated by the fiscal support governments provided during the pandemic. New lockdowns in China also played a role by worsening inflation and causing additional bottlenecks in global supply chains. The war added an additional series of supply shocks as it restricted access to Russian oil, gas, and metals, as well as Ukrainian wheat and corn. This surge in fuel and food prices has been most acutely felt in European economies. Look for coordinated action from the G7 on unblocking ports and relieving some of the pressure on food supply. 

—Niels Graham is an assistant director in the GeoEconomics Center.

3. Sanctions against Russia

G7 countries have imposed unprecedented coordinated sanctions and export controls against Russia with the goal of turning the country into a global economic pariah and increasing the cost of waging its war in Ukraine. While the original G7 agenda does not mention Russia or Ukraine by name, there’s no doubt that one of its goals is to safeguard global economic recovery and financial stability—both of which are currently undermined by Russia’s invasion of Ukraine. Addressing the challenges of supply-chain disruptions and global food shortages will require G7 partners to reintegrate Ukraine into the world economy and provide financial assistance to Kyiv. 

Fortunately, the seven countries are on the same page when it comes to funding Ukraine, having pledged twenty billion dollars to prop up Ukraine’s budget. But as Ukraine’s finance minister said during an event at the Atlantic Council last month, not all that money has reached its bank account. Kyiv will have the chance to make the case in person: President Volodymyr Zelenskyy has accepted the German chancellor’s invitation to take part in this year’s G7 summit. 

—Maia Nikoladze is a program assistant in the Economic Statecraft Initiative within the GeoEconomics Center.

4. Guidance on interest rates

Hindsight is 20/20—and for the G7, it might indeed be a good idea to look back. Forecasting is always a precarious business, which is why many international organizations temporarily suspended economic prognostication in the thick of the pandemic. But the US Federal Reserve and European Central Bank didn’t have that luxury; they had to do their best to estimate gross domestic product (GDP) growth, inflation, and interest rates over multiple years despite the fog of an unprecedented supply chain crisis and mutating virus. 

It didn’t work out as they had hoped: The forecasts varied so widely over the past year that it called into question whether they were even worth doing in the first place. So should the G7 nations keep trying to forecast to markets what’s coming, or simply deal with what’s right in front of them? Expect some humility from the leaders this week as they work to address the immediate inflation crisis—while recognizing that neither they nor the brilliant economists in their governments can predict the next global pandemic, or how the war in Ukraine will end.

—Josh Lipsky is the director of the GeoEconomics Center

5. G7 debt vs. emerging-market debt

Germany’s emphasis during its G7 presidency on financial stability and inclusive growth means debt will be a key theme at this year’s summit. In response to the pandemic, countries worldwide pushed through massive fiscal-stimulus packages to provide economic relief. While debt-to-GDP ratios are elevated for all countries compared to pre-pandemic levels, they are slowly beginning to subside for G7 economies—but still have yet to peak for emerging markets and developing economies. Tighter US and European monetary policy, surging commodity prices, and a drastic decline in global-trade growth will hamper their ability to retain dollars and service their unprecedented levels of debt. 

As the risk of debt default increases for those countries, G7 members should take steps to ensure that the G20 Common Framework for Debt Treatments is implemented effectively. This means China, as the world’s largest bilateral creditor, needs to step up and help renegotiate with countries to avoid default. Look for how the G7 coordinates this week ahead of next month’s G20 finance ministers meeting in Indonesia—and watch whether it takes up US Treasury Secretary Janet Yellen’s call at the Atlantic Council in April for a reform of the Bretton Woods system. 

—Mrugank Bhusari is a program assistant in the GeoEconomics Center.

6. CBDC and Cryptocurrencies

All of the G7 economies are in the process of developing a Central Bank Digital Currency (CBDC) to promote digital transformation and provide more efficient payment systems. Canada, France, Germany, Italy, and Japan are in the more advanced stage of development and have been testing both retail and wholesale CBDCs since April 2021. The first three, in particular, are helping create the digital euro. The United States and United Kingdom are the farthest behind on CBDC development, as both are currently in the process of establishing research partnerships. In the former, President Joe Biden’s executive order on digital assets initiated further research and interagency coordination for the digital dollar. The G7 has shared concerns regarding privacy and cybersecurity of the different CBDC models.

When it comes to cross-border testing, the focus of the G7 should be on interoperability across the various domestic CBDC models, legacy payments infrastructure, as well as regulated, private digital currencies. This is not just an abstract problem: When the G7 cut Russia off from SWIFT, it increased incentives for countries like China to find new ways to send money across borders. Meanwhile, the collapse of cryptocurrency markets is reminding regulators why they need to step in and help protect consumers. 

CBDC Tracker

The new Central Bank Digital Currency (CBDC) Tracker & interactive database takes you inside the rapid evolution of money all over the world.

—Ananya Kumar is the assistant director of digital currencies at the Atlantic Council.

7. Vaccination rates

At last year’s G7 summit, the first item on the agenda was to end the pandemic by vaccinating the world. Leaders adopted the World Health Organization’s goal of vaccinating 70 percent of every country’s population by mid-2022 and committed to sharing at least 870 million doses within a year. Unfortunately, only 17.8 percent of people in low-income countries have now received at least one dose. Resolving this crisis requires equitable distribution.

A successful global vaccination push by the G7 will contribute to global immunity, reduce the risk of new variants emerging, and enable the resurgence of the global economy. The pharmaceutical industry has produced more than thirteen billion doses, but low-income countries still face obstacles due to supply-chain bottlenecks and intellectual-property protections. These are challenges that the World Trade Organization’s recent decision to ease intellectual-property restrictions on vaccines fails to address. This year, G7 commitments toward both vaccine supply and global distribution strategies will be a deciding factor in resolving the COVID-19 pandemic and resulting economic blight.

—Sophia Busch is a project assistant in the GeoEconomics Center.

The post Seven trends to watch as the world’s richest countries get together appeared first on Atlantic Council.

The Fed’s aggressive policy stance will also bring significant economic costs. The FOMC revised its estimate for 2022 GDP growth downward to 1.7% from 2.8% in its March forecasts, and the unemployment rate upward to 4.1% by 2024, from today’s 3.6% rate. Still, the Fed also expects inflation to trend down towards 2% by then from 8.6% in May. Such an outcome is considered by Chairman Powell to be consistent with his expectation of a “soft or softish landing” from the current bout of 40-year high inflation.

However, whatever the Fed may have hoped to gain by acting forcefully to push back market perception of it being “behind the curve”, it has raised serious concerns about tipping the economy into a recession. This will be the case if the US experiences another GDP contraction in the second quarter following the 1.5% decline in the first quarter. Tellingly, the Atlanta Fed GDPNow model has just estimated a flat second quarter, putting the US economy on the brink of a recession.

As ever, the Fed’s actions will have ramifications around the world. First and foremost, they will put pressure on the European Central Bank (ECB) to tighten at their next meeting in July in the face of record-high inflation of 8.1% in May in the Euro area. However, the ECB’s task has been complicated by the need to address widening sovereign bond yield spreads of peripheral highly-indebted members like Italy and Greece, versus the preeminent core country, Germany. In a rare emergency meeting on June 15, the ECB promised to use its current bond purchase program flexibly by tilting the reinvestment of maturing debt toward weaker members to prevent bond yield spreads from getting out of hand. It will be launching an “anti-fragmentation instrument” soon to help reduce tension within the European monetary system.

However, in contrast to the 2010 Euro area sovereign debt crisis, inflation now gets in the way. A bond-buying program will now be at odds with the need to tighten monetary policy to bring inflation back under control. Raising the floor for rates while attempting to lower long-term bond yields in peripheral countries is inherently contradictory and may end up compromising the efficacy of both operations. This could leave the Euro area vulnerable to stubbornly high inflation and widening spreads of peripheral sovereign bonds. This is an unsettling prospect given the high level of uncertainty caused by the war in Ukraine.

The Bank of England has raised its policy rate the fifth time by only 25 basis points, but said that it would “act forcefully” if needed to prevent persistent high inflation. The Swiss National Bank has also increased its policy rate by 50 basis points for the first time in 15 years.

For some countries where inflation remains moderate, the Fed’s actions have constrained the ability of central banks to support their slowing economies. In particular, the  to ease monetary policy much to support stalling growth for fear of further weakening the RMB against the USD. China has just begun to recover from the slowdown triggered by the debt crisis of property developers and a series of lockdowns in Shanghai and parts of Beijing due to Covid-19 infection waves. However, these risks are still very much present and could return to slow growth again before too long.

The Fed’s actions will intensify headwinds already affecting most emerging markets and developing countries. Weaker growth in the US and China will reduce demand from two key markets for their commodity exports. Higher US interest rates and a stronger USD have triggered net capital outflows from emerging markets, tightening financing conditions. The war in Ukraine continues to raise energy and food prices amid severe food shortages in poor countries. Many developing and low-income countries with high levels of debt and debt-servicing burdens will be pushed into economic and debt crises in the foreseeable future.

In short, the Fed may well have been right in taking forceful actions now to fight inflation after failing to control it, but such actions add to the challenges experienced by economies around the world.

Hung Tran is a nonresident senior fellow at the Atlantic Council, former executive managing director at the International Institute of Finance and former deputy director at the International Monetary Fund.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

Related reading

Econographics Aug 3, 2022

Trading geopolitics: The US-Chinese capital markets

By Elmar Hellendoorn

Increased Chinese-Western capital market integration is just one scenario. Instead, ”strong decoupling” or “muddling through” may prove more likely.

China Economy & Business

Blog Post Jan 28, 2022

China’s capital markets in the shadow of the CCP

By Elmar Hellendoorn

Under Chinese President Xi Jinping Chinese capital markers have become increasingly politicized as politics increasingly influence Chinese businesses. This politicization may have significant implications for those investing in Chinese financial assets.

China Economy & Business

Issue Brief Sep 14, 2022

Sand in the silicon: Designing an outbound investment controls mechanism

By Sarah Bauerle Danzman and Emily Kilcrease

The stakes for rethinking the investment relationship between the United States and China are high. An outbound investment mechanism must be narrowly targeted, clearly defined, non-duplicative of existing tools, scoped proportionately to administrative capacity, and paired with meaningful multilateral engagement with allies and partners. 

China Economy & Business

The post The Fed has regained the initiative, but at a cost appeared first on Atlantic Council.

Can they stop the runaway train? The US Federal Reserve hiked its benchmark interest rate by three-quarters of a percentage point Wednesday in an effort to curb rocketing inflation. The single biggest rate increase since 1994 will probably cool down the economy—but it will be a difficult balance to tame inflation without sending the world’s largest economy into a downward spiral. Our global economic experts take you behind the numbers to understand what’s next in this uncertain monetary moment for the United States and the wider world.

• Josh Lipsky (@joshualipsky): Senior director of the Atlantic Council’s GeoEconomics Center
• Ole Moehr (@ACGeoEcon): Fellow with the GeoEconomics Center

LOW PRICES, GUARANTEED?

• Josh tells us the precise amount of the rate hike actually doesn’t matter as much as the bank “sending a signal to markets that the Fed has this under control. It’s about restoring confidence.” 
• So will it help whip inflation, which now sits at a forty-year high? That’s where it gets more complicated, Josh adds: “Here’s a great economics answer: Yes and no.” While hiking rates won’t help with soaring gas prices in the short term, it will ease demand for everything from homes to everyday goods. “If money is more expensive to borrow, people will borrow less and spend less, and prices will come down.” 
• But Ole notes that a series of rate hikes alone won’t do the trick in a highly interconnected global economy. “If the Fed’s actions are accompanied by an easing of global supply bottlenecks, we should see inflation come down significantly in 2023.”

Subscribe to Fast Thinking email alerts

Sign up to receive rapid insight in your inbox from Atlantic Council experts on global events as they unfold.

• Email*
• Name
  This field is for validation purposes and should be left unchanged.

READY FOR A RECESSION?

• While the Fed doesn’t have a great record in cooling the economy without freezing it, Josh tells us, history offers some hope—since then Fed Chairman Alan Greenspan’s 1994 rate hike “was one of the rare circumstances where the Fed did engineer a soft landing.”
• But recent history is less encouraging, Josh adds: When sources inside the bank signaled ahead of today’s meeting about a higher-than-expected hike, their urgency to warn financial markets was an ominous sign. “Translation? The Fed is worried.”
• The Fed hoped to avoid a move like this, Ole says, but signs of broader inflation across the economy (such as rents continuing to rise and consumers spending more on services) required a more hawkish turn even though it “shrinks the landing strip to avoid a recession.” He adds that “today’s decision makes it more likely that the US economy is headed toward a downturn within the next two years.”  
• And if the rate hikes don’t tame consumer demand, things could get worse, Ole tells us: “The US economy could face a worst-case stagflation scenario of high unemployment, high inflation, and low growth.”

KNOCK-ON EFFECTS

• Central banks around the world are adjusting to this new moment, as GeoEconomics Center research shows. All eyes are now on the European Central Bank, Ole says, which called an emergency meeting today and is expected to soon follow the Fed’s example. “The ECB must now attempt a balancing act of tightening monetary policy to lower inflation while continuing to provide support for economically vulnerable euro area countries.”
• Broadly, though, “the Fed raising rates is a problem for the whole world,” Josh believes. That’s because a strong dollar and high rates will compel investors to pull their cash from other countries and park it in the United States. “That can really hurt an emerging market economy and, in fact, cause an economic crisis for these countries.”
• That will lead to other central banks raising their rates to compete, Josh adds—with the end result being “tighter money all around the world and, unfortunately, a decent chance of a global recession.”

The post FAST THINKING: The Fed pulls the emergency brake. Will it work? appeared first on Atlantic Council.

Table of contents

Foreword
Executive summary
Background: How the United States currently secures its payment systems
Payments overview
Looking ahead to CBDCs

Chapter 1: Cybersecurity of CBDCs – threats and design options
Roles and trust assumptions
Threat model
CBDC design variants
Additional key design choices

Chapter 2: Policy recommendations – Principles for future legislation and regulation
Principle 1: Where possible, use existing risk management frameworks and regulations
Principle 2: Privacy can strengthen security
Principle 3: Test, test, and test some more
Principle 4: Ensure accountability
Principle 5: Promote interoperability
Principle 6: When new legislation is appropriate, make it technology neutral

Conclusion
Appendix: Lessons from the Federal Reserve’s Current Cybersecurity Measures for Deploying CBDCs
Public wholesale layers
Private wholesale layers
Retail payments
About the authors and acknowledgements

Foreword

The challenge of securing the dollar dates back to the earliest days of the United States. Benjamin Franklin famously printed currency with the phrase “to counterfeit is death”—and colonial England used fake currency to try to devalue the Continental Dollar during the American Revolution.

In the modern era, security issues have multiplied with the rise of the Internet and the threat of cyberattacks. The United States Federal Reserve (Fed) considers cybersecurity a top priority and sees securing both the dollar and the international financial system as a core national security challenge. We are entering a new era of security and currency, one that requires responsible innovations in digital currency. This report examines the novel cybersecurity implications that could emerge if the United States issues a government-backed digital currency—known as a central bank digital currency (CBDC) or “digital dollar.”

This topic is fast-moving, consequential, and still somewhat nascent.

CBDCs have quickly landed on the international policy landscape. As of June 2022, according to Atlantic Council research, 105 countries representing 95 percent of the global GDP are researching and exploring the possible issuance of CBDCs. In the United States, spurred on by various domestic and international factors, the Fed has begun studying the issue and published a white paper in January 2022 that examines the potential benefits and risks of issuing a CBDC. In February 2022, the Federal Reserve Bank of Boston, in collaboration with the Massachusetts Institute of Technology, released test code and key findings on what a possible US CBDC might look like. But the government has so far demurred on whether it will actually issue a digital dollar, calling upon Congress to authorize such a major decision. Further complicating matters is the rapid ascendance of privately issued crypto dollars, sometimes referred to as stablecoins, which now surpass $130 billion in total market capitalization. As Fed Vice Chair Lael Brainard testified to the US House of Representatives’ Committee on Financial Services in May 2022, the recent collapse of the stablecoin TerraUSD raises new questions about the ways in which a CBDC could stabilize the digital asset ecosystem. 

The security of CBDCs has real-world import and is one of the major challenges to overcome if a CBDC is to be issued in the United States. Not just because of the classical counterfeiting scenarios or the possibility of a hacker looting the digital equivalent of Fort Knox, but also because a government-administered digital currency system could—depending on how it is designed—collect, centralize, and store massive amounts of sensitive data about individual Americans and granular details of millions of everyday transactions. For example, a CBDC could contain large volumes of personally identifiable information ranging from what prescription drugs you buy or where you travel each day. This could become a rich trove of data that could be stolen by advanced hackers or nation-states (similar to reams of personal data collected from federal employees that was stolen in 2016). Separately, other security issues could arise, for example, misuse or exfiltration of data by inside employees, smaller-scale identity theft, or “gray” charges via opaque fees. However, as our analysis shows, many of these risks already exist in the current system and could be mitigated through an effectively designed CBDC.

The security of CBDCs has real-world import and is one of the major challenges to overcome if a CBDC is to be issued in the United States.

The debate around CBDCs in the United States is also, relatively speaking, in its infancy, with the Fed and Treasury Department often taking the lead thus far, and several CBDC-related bills percolating through Congress. Part and parcel of the conversation about how and whether to develop a CBDC in the United States is what it will look like and how secure it could be. These intertwined questions of policy, design, and security should be an increasing focus of the conversation, both among federal agencies and between the executive branch and Congress. The United States can, and should, play a leading role in international standard setting. US President Joseph R. Biden, Jr.’s recent executive order highlighted the importance of digital assets protecting democratic values. 

This report introduces key concepts, potential design trade-offs, and some policy principles that we hope can help federal stakeholders make foundational decisions around the future of CBDCs in the years ahead. While it is too early for a CBDC to be designed with ideal cybersecurity, efforts to dismiss a CBDC as uniquely and categorically vulnerable to cyberattacks have overstated the risk. This report puts forward a road map for policy makers to build secure CBDCs. 

Executive summary 

This report examines the novel cybersecurity implications that could emerge if the United States or another country issues a Central Bank Digital Currency (CBDC). Central banks consider cybersecurity a major challenge to address before issuing a CBDC. The United States Federal Reserve (Fed) sees securing both the dollar and the international financial system as a core national security imperative. According to Atlantic Council research, currently 105 countries have been researching and exploring the possible issuance of CBDCs, with fifteen in pilot stage and ten fully launched.¹ Of the Group of Twenty (G20) economies, nineteen are exploring a CBDC with the majority already in pilot or development. This raises immediate questions about cybersecurity and privacy. A government-issued digital currency system could, but does not necessarily need to, collect, centralize, and store massive amounts of individuals’ sensitive data, creating significant privacy concerns. It could also become a prime target for those seeking to destabilize a country’s financial system. 

This report analyzes the intertwined questions of policy, design, and security to focus policy makers on how to build secure CBDCs that protect users’ data and maintain financial stability. Our analysis shows that privacy-preserving CBDC designs are not only possible, but also come with inherent security advantages, compared to current payment systems, that may reduce the risk of cyberattacks. Divided into three chapters, the report:

(1) provides a brief background on the Fed’s process as a baseline for central banks’ current cybersecurity measures;

(2) explores the novel cybersecurity implications of different potential CBDC designs in depth; and 

(3) outlines legislative and regulatory principles for policy makers in the United States and beyond to set the conditions for secure CBDCs.

Payment systems’ status quo: How the Federal Reserve currently secures payments

Current wholesale and retail payment systems face a complex cybersecurity landscape and represent a major point of attack for both organized crime and state-sponsored actors. Cybersecurity risks posed by CBDCs must be assessed relative to this landscape.

A targeted attack on wholesale payment infrastructures, such as the Fed’s domestic funds transfer system, Fedwire, could cause major global financial shocks, including severe liquidity shortfalls, commercial bank defaults, and system-wide outages that would affect most daily transactions and financial stability. There would also be secondary effects, including severe market volatility. To minimize the risk of cyberattacks and reduce the impact of successful hacks, the Fed’s current measures include regular contingency testing for high-volume and high-value Fedwire participants; redundancy requirements, such as backup data centers and out-of-region staff; and transaction value limits. Other risks for the wholesale payments infrastructure include attacks on the Society for Worldwide Interbank Telecommunications (SWIFT) messaging system. After recent attacks revealed significant vulnerabilities, SWIFT and its member banks have taken several steps to shore up their defenses, focusing on stronger security standards and quicker response.

Key cybersecurity risks for retail payment systems include credit and debit fraud, which collectively caused nearly $25 billion in damages in 2018 worldwide; fraud by system insiders affecting platforms like the Automated Clearing House (ACH) in the United States; and user error, such as falling prey to phishing scams. Risk management strategies for retail payments often rely on voluntary industry standards, such as the Payment Card Industry Data Security Standard (PCI DSS). To counter phishing and other types of user error, ACH and other platforms require unique user credentials and offer merchants additional steps like micro validation, tokenization and encryption, and secure vault payments.

In sum, the various technical systems administered by the Fed, industry associations, and private banks already face considerable cybersecurity challenges.

Cybersecurity of CBDCs—Threats and design options

While a CBDC would be subject to many of the same cybersecurity risks as the existing financial systems, deployment of a CBDC would also create new risks. Depending on the choice of CBDC design, potential new cybersecurity risks include (but are not limited to): 

• Increased centralization of payment processing and sensitive user data. It is possible a central bank would store user activity and transactions. 
• Reduced regulatory oversight of financial systems
• Increased difficulty reversing fraudulent or erroneous transactions 
• Challenges in payment credential management and key custody
• Susceptibility to erroneous or malicious transactions enabled by complex, automated financial applications
• Increased reliance on third parties (e.g., non-banks)

The exact set of new cybersecurity risks depends largely on the digital currency variant that a country chooses for its CBDC system. Each digital currency variant also provides different properties in terms of system scalability, system robustness, user privacy, and networking requirements. Since each currency design variant presents different trade-offs in terms of performance, security, and privacy, the choice of which digital currency design variant to deploy as a CBDC is a policy choice for finance ministries, central banks, and legislatures. It should be driven by a thorough analysis of the relative technical trade-offs. This report reviews various possible digital currency design variants and compares the benefits and risks of each. Our analysis also challenges the prevailing thinking in several ways and outlines the following findings:

Finding 1: The design space for CBDCs is larger than the often-presented trifecta of centralized databases, distributed ledgers, and token models.

• For example, this means that both ledger and token-based payments can embody robust privacy protection through certain cryptographic measures.

Finding 2: CBDCs can enable both strong user privacy and (some level of) regulatory oversight at the same time.

• It is possible to design systems where users enjoy reasonable levels of payment privacy and regulatory authorities can at the same time advance other important policy goals.

Finding 3: A privacy-preserving currency design can inherently provide security advantages.

• In a privacy-preserving CBDC deployment that initially declines to collect or subsequently restricts sensitive user data even from trusted system insiders, breaches will have significantly less severe security consequences.

Finding 4: It is critical to use best practices from system design, such as proven consensus protocols and cryptographic primitives.

• Distributed security protocols, such as those used to secure distributed ledgers, can introduce subtle new design challenges and security trade-offs. This report encourages the use of well-tested protocols with provable security guarantees as key components of CBDC deployments.

Principles for future legislation and regulation

With most governments, including in the United States, still weighing whether to develop a CBDC, this report identifies key principles to help guide policy makers and regulators on how to deploy a CBDC with robust cybersecurity protections in mind.

Background: How the United States currently secures its payment systems 

Cybersecurity is an area of concern not only for CBDCs but also the current financial and payment systems. Any study of CBDCs’ cybersecurity must assess them relative to this current infrastructure and recognize how they will interact to alter and potentially remedy existing vulnerabilities. Additionally, it must draw lessons from how central banks currently handle payments’ cybersecurity.

The Fed has recognized the immense risks posed by cyberattacks to the current financial system. Asked in April 2021 about the chances for a systemic breakdown like the 2008 financial crisis, Federal Reserve Chairman Jerome Powell said that “the risk that we keep our eyes on the most now is cyber risk.” He specifically singled out a scenario in which a “large payment utility…breaks down and the payment system can’t work” or “a large financial institution would lose the ability to track the payments that it’s making.”² At a conference in October, Loretta J. Mester, president of the Federal Reserve Bank of Cleveland, argued “there is no financial stability without cybersecurity.”³ As the issuer of the world’s reserve currency, the Fed’s cybersecurity models hold outsized importance for the global economy. The Fed’s standards have also become models for cybersecurity across central banks. 

Payments overview

The current payment system comprises three categories: retail, wholesale, and cross-border.⁴ Retail payments are what the vast majority of Americans interact with: purchasing groceries with a credit card, buying Cracker Jack at a baseball game with a five-dollar bill, or shopping online with payment service providers. The wholesale system operates in the background, serving as the plumbing of the financial system by enabling the transfer and settlement of funds between financial institutions. Cross-border payments are between different countries and require international coordination to bridge national systems.

All three of these systems could be impacted or overhauled by CBDC. CBDC is the digital form of a country’s fiat currency that is also a claim on the central bank. Instead of printing money, the central bank issues electronic coins or accounts backed by the full faith and credit of the government. This differs from current “e-money” because it is a direct liability of the central bank, like paper cash. A CBDC could take multiple forms: a retail CBDC would be issued to the public to enable fast and secure payment, while a wholesale CBDC would only be accessible by banks and would facilitate large-scale transfers. According to the Atlantic Council’s CBDC tracker, forty-five of the 105 countries pursuing a CBDC are focused on its retail use, while eight are exclusively developing it for a wholesale purpose, and twenty-three are doing both (with the remaining twenty-nine undecided).⁵ On the cross-border payments front, multiple partnerships between countries, such as Project Dunbar among South Africa, Singapore, Malaysia, and Australia, are piloting cross-border payments using CBDCs.

A CBDC could take multiple forms: a retail CBDC would be issued to the public to enable fast and secure payment, while a wholesale CBDC would only be accessible by banks and would facilitate large-scale transfers.

The key components of the United States’ current payment systems are described below.⁶

• Fedwire is the Fed’s domestic and international funds transfer system that handles both messaging and settlement. 
• Clearing House Inter-Payments System (CHIPS), privately operated and run by its member banks, handles dollar-denominated domestic and international funds transfers.⁷
• The Society for Worldwide Interbank Telecommunications (SWIFT), operated as a consortium by member financial institutions, is a global messaging system that interfaces with Fedwire and CHIPS for the actual settlement of payments.⁸
• FedNow will complement the Fed’s Fedwire with instant, around-the-clock settlement and service. A full rollout is planned over the next two years. 
• The Automated Clearing House (ACH) is a network operated by the National Automated Clearing House Association (Nacha) that aggregates US transactions for processing and enables bank-to-bank money transfers.

While CBDCs will likely play a role in all three levels of the payment system, this background chapter as well as the report’s appendix predominantly examine risks to payment systems in which central banks are involved. That currently means the wholesale system. The Fed’s approach to securing wholesale payments sheds light on its current cybersecurity practices and how it might handle a CBDC. We also briefly examine the retail payment system to understand cyber risks that a retail CBDC could impact.

A targeted attack on wholesale payment infrastructures, such as Fedwire, could cause major global financial shocks, including severe liquidity shortfalls, commercial bank defaults, and system-wide outages that would affect most daily transactions and financial stability. There would also be secondary effects, including severe market volatility. To prevent cyberattacks and reduce the impact of successful hacks, the Fed’s current measures include regular contingency testing for high-volume and high-value Fedwire participants; redundancy requirements, such as backup data centers and out-of-region staff; and transaction value limits. Other risks for the wholesale payments infrastructure include attacks on the SWIFT messaging system. After recent attacks revealed significant vulnerabilities, SWIFT and its member banks have taken several steps to shore up their defenses, focusing on stronger security standards and quicker response times. 

Key cybersecurity risks for retail payment systems include credit and debit fraud, which collectively caused nearly $25 billion in damages in 2018 worldwide; fraud by system insiders affecting platforms like ACH in the United States; and user error, such as falling prey to phishing scams.⁹ Risk management strategies for retail payments often rely on voluntary industry standards, such as the PCI DSS. To counter phishing and other types of user error, ACH and other platforms require unique user credentials and offer merchants additional steps like micro validation, tokenization and encryption, and secure vault payments.

Information security is generally assessed along three core principles known as the CIA triad: confidentiality, integrity, and availability.¹⁰ Confidentiality requires that data are only accessible to those who are authorized.¹¹ For payments, this means that data about participants and their transactions are kept private. Countermeasures to ensure confidentiality focus on areas like authentication, encryption, and educating users.¹² Integrity means that data are “correct, authentic, and reliable” and can thus be trusted to not have been tampered with.¹³ This is accomplished via hashing and controlling access.¹⁴ In payments, integrity is linked to the need for non-repudiation: the payor cannot deny sending the payment, and the payee cannot pretend to have not received it.¹⁵ Finally, availability means that the system is up and running, allowing users to have timely and reliable access.¹⁶ In payments, this could be hampered by an attack on a specific institution or by the failure of supporting infrastructure like data centers. Securing availability can be done by hardening systems against attacks and building in redundancy.¹⁷

Looking ahead to CBDCs

Chapter 1 assesses the cybersecurity risks facing CBDCs and how design choices will shape vulnerabilities using a framework derived from the CIA triad but customized to the challenges of CBDCs. Understanding how CBDCs will fit into the existing landscape is crucial for turning this insight into actionable steps for policy makers, which we explore in Chapter 2. 

Chapter 1: Cybersecurity of CBDCs—Threats and design options

This chapter discusses the cybersecurity of CBDCs. A central theme, which pervades all aspects of this chapter, is how CBDCs may centralize data and control over the financial system. Although the current financial system is already relatively centralized (e.g., in the United States, more than 50 percent of banking assets in 2022 are controlled by just four banks)¹⁸ CBDCs have the potential to significantly increase centralization by storing a single ledger or similar data repository that aggregates transaction data from all participants. The ledger could even include data from payment modalities that are currently difficult to monitor, such as cash. Such dramatic centralization of CBDCs could have downstream effects that are difficult to predict or manage. For example, a database containing an entire nation’s financial transactions would represent an unprecedented target for cybercriminals. It can also provide unscrupulous regimes with a mechanism for mass surveillance. Such threats can be mitigated in part through technical design choices, but every design comes with implications (and trade-offs) regarding security, privacy, performance, and usability, to name a few. This chapter discusses a landscape of possible design variants, while highlighting the relevant trade-offs.¹⁹

We start our discussion by introducing the different roles that would be involved in a typical CBDC deployment, their primary tasks, and trust assumptions. After that, we introduce a threat model for CBDCs by discussing the main security requirements and involved threat actors. Then, we review common digital currency variants and analyze them with respect to the established threat model. We complete our analysis with a comparison that shows the main advantages and drawbacks of different currency designs. Finally, through case studies, we show how a few noteworthy CBDC pilot projects fit into our classification. The key contributions of this chapter are as follows.

Key contributions of this chapter

​​Systemize knowledge: We define a framework for systematically analyzing and comparing digital currency designs. We show the main pros and cons of common digital currency variants and explain how noteworthy existing CBDC pilot projects fit into our classification. We also identify potential cybersecurity risks involved in each currency variant.

Highlight recent research advances: As part of our review, we also highlight recent developments from the research community and possible digital currency design alternatives that are not yet typically considered in most CBDC reports. Such designs can enable improved user privacy or transaction validation scalability, for example.

Clarify common misconceptions: Throughout our discussion, we also point out common misconceptions, recurring harmful practices, or otherwise bad patterns related to the design and deployment of digital currencies. 

Roles and trust assumptions

Currency issuer. Every CBDC system needs an entity that creates money. We call this role currency issuer. In most envisioned CBDC deployments, this role would be played by a central bank. In a private digital currency, this role could also be played by a private company. The currency issuer should be trusted by all system participants for the correctness of money creation. That is, the money created by the issuer is considered valid by everyone involved in the system. This entity does not necessarily need to be trusted for all other aspects of the system, such as user privacy or payment validation.

Payment validator. CBDC systems require entities that keep the system running and provide the needed infrastructure for other participants. One such infrastructure role is the payment validator that approves payments and records them into data storage, such as a database or ledger. The role of the payment validator could be distributed among several nodes for increased security and performance, as will be discussed later in this chapter. The role of the payment validator could be taken by the central bank, or alternatively, it could be delegated to another public authority or to commercial banks. The payment validator needs to be trusted to verify the correctness of payments, but not necessarily for other properties, such as money creation or user privacy.

Account provider. Another infrastructure role in a typical retail CBDC system is an account provider that allows users to register, obtain payment credentials (e.g., in the form of a digital wallet), and start making CBDC payments. In most retail CBDC deployments, the account issuer would need to verify the identity of the user before account creation. Most likely, central banks would not want to interface with users directly and, therefore, this role would be better served by commercial banks that already have existing customer relationships. The account provider, such as a commercial bank, would need to be trusted for the verification of users’ identities. In a custodial solution, the account provider could be also trusted with the management of users’ payment credentials and it could control users’ monetary assets. In a non-custodial solution, the account provider would not control any monetary assets on behalf of the users. The role of account provider may not be needed in a wholesale CBDC deployment where the end users are financial institutions like commercial banks.

Payment sender and recipient. We consider two types of end users: payment senders and payment recipients. In a retail CBDC system, such users could be private individuals, commercial companies, or other legal entities. Such users would typically perform payments through a client device such as a smartphone that holds the payment credentials obtained from the account provider. For specific use cases like visiting tourists other solutions are likely to be needed for obtaining payment credentials. In a wholesale CBDC, the payment sender and recipient could be commercial banks performing an inter-bank settlement. Payment senders and recipients are generally not trusted by other system participants. Instead, it is assumed that users may behave arbitrarily or even fully maliciously.

Regulator. Another role that we consider is the regulator. The task of the regulator is to ensure that all payments in the system conform to requirements such as anti-money laundering rules. For example, in the United States, the recipients of a cash payment worth more than $10,000 are required to report the payment details to the Internal Revenue Service (IRS). In a CBDC deployment, all payments that exceed a similar threshold amount could be automatically forwarded to the regulator for audit. While the regulator is trusted to examine specific payments and report non-conforming payments, in a well-designed CBDC system, all details of all payments do not necessarily need to be visible to the regulator. For example, receiving $50 fully anonymously (i.e., such that even the regulator cannot see the payment details of the transaction) should be possible. We discuss the challenges involved in realizing such privacy-preserving regulation later in this chapter.

Technology provider. In a retail CBDC, the needed payment application could be provided by a technology company. For example, in the digital yuan pilot in China, the CBDC payment functionality is integrated into popular smartphone payment applications, such as Alipay from Ant Group and WeChat Pay from Tencent. In addition to providing the payment application, in a custodial deployment, the technology provider may assist the user in payment credential management. The end users (i.e., payment senders and recipients) need to trust the technology provider for the correctness of the payment application and potentially also for the management of payment credentials. In a wholesale CBDC, the payment senders and receivers (commercial banks) could obtain the needed (settlement) technology from an external software vendor.

Figures 1a and 1b below illustrate the typical relationships between these roles in retail and wholesale CBDC deployments, respectively. 

Figure 1a. Main roles involved in a retail CBDC system

Figure 1b. Main roles involved in a wholesale CBDC system

Threat model

To understand the cybersecurity implications of CBDCs, it is important to first specify the threat model. In this section, we will highlight the security requirements and the threat actors that are relevant to CBDCs. 

Requirements

CBDCs should satisfy a number of properties, both security and performance related. These requirements are intertwined: different design variants can have different implications for each of these requirements. 

Integrity. The integrity of a financial system refers to its ability to ensure that money transfers and creation is correct. In other words, it should not be possible to create or delete money out of thin air. It should also not be possible to transfer funds that do not belong to the sender. 

Authentication and authorization. Only the legitimate owner of money should be able to transfer said money. In current payment systems, this is typically achieved through a two-step process. Authentication refers to the process of verifying a user’s identity.²⁰ Authorization refers to the process of verifying the transaction details, such as the recipient’s identity and the amount to be paid. In some CBDC design variants, these two processes can be intertwined, so we address them jointly in this report. 

Confidentiality. Transactions should not be visible to unauthorized parties (e.g., telecommunications providers). Confidentiality is typically achieved via encryption of data in transport over untrusted channels. Such techniques are widely used in the banking industry today, and we do not expect them to vary significantly across different CBDC variants (though they may need to be updated due to emerging technologies, such as quantum computing). Because of this, we will not analyze confidentiality separately in the remainder of this document. 

Privacy. Whereas confidentiality aims to protect data from unauthorized parties, privacy aims to protect user information (e.g., payment transaction details) from authorized parties, such as payment validators. While these two concepts are closely related, we treat them as separate. Deciding what level of privacy to provide is a political decision as well as a technical one, and has repercussions for the architecture and design of the CBDC. 

Incorporating privacy protections into a CBDC design is important for two main reasons. The first reason is that the privacy of end users is valuable in itself. CBDCs will inevitably aggregate tremendous amounts of financial data, and consequently some national banks have indicated that their goal is not to build a tool of mass surveillance.²¹ Additionally, the successful adoption of CBDC technology may require that the deployed system meets the privacy expectations of end users. In a recent survey on the digital euro, participants rated privacy as the most important feature of a possible CBDC deployment.²² The second reason is that a system with strong privacy protections is also inherently more secure. If a system that collects huge amounts of sensitive user data does not include privacy protections and is breached, then all the sensitive information will be disclosed to the attacker and, potentially, to other unauthorized parties, which violates confidentiality. In a privacy-preserving design that hides sensitive user data even from trusted system insiders, a similar breach or insider attack will have significantly less severe consequences for security and confidentiality.

Takeaway: Privacy-conscious design can also provide security benefits
If a CBDC deployment without privacy protections is breached, either by an external attacker or a malicious insider, then all the sensitive user information is disclosed to unauthorized parties. In a privacy-preserving CBDC deployment that hides sensitive user data even from trusted system insiders, breaches will have less severe security consequences.

Resilience. The system should be robust to faults, or failures, of different components of the system. Typical faults include infrastructure failures (e.g., a server crashes), software-level failures (e.g., a program stops executing), and protocol-level failures (e.g., a validator node misbehaves). Faults can be either accidental (e.g., random infrastructure failures) or intentional (e.g., caused by misbehaving nodes). 

An important aspect of resilience is availability. System availability is often specified in terms of uptime; a common goal is “five nines,” i.e., the system is operational 99.999 percent of the time. As a result, the system must be able to process payments even if some parties are offline, including back-end infrastructure, the payment sender, or the payment recipient.

Another relevant dimension of resilience is transaction revertability. Fraudulent transactions are very common in financial systems. Ideally, if a transaction can be shown to be fraudulent, authorized parties, such as payment validators, should be able to revert the transaction, i.e., add the paid amount back to the payment sender’s account balance and deduct the paid amount from the recipient’s balance. 

Network performance and costs. The system must be highly performant to process nation-scale financial transactions. Common performance metrics include throughput (number of transactions that can be processed per second) and latency (time to transaction confirmation). For comparison, the Visa credit card network currently processes 1,700 transactions per second on average and is capable of processing up to 24,000 transactions per second.²³ Meanwhile, typical transaction latencies for digital payments are in the order of seconds. 

In exchange, CBDCs will inherently incur communication (or bandwidth) and computation costs. These costs are divided between the back-end infrastructure and end users. In general, a CBDC is expected to impose high costs on back-end infrastructure, both in terms of computation and communication. As such, we do not focus further on back-end resource costs in this report. However, certain potential designs (e.g., privacy-preserving ledgers) require access to the entire ledger, in encrypted form, to verify the validity of transactions. This imposes significant bandwidth requirements on end users, as well as substantial computational requirements. These costs must be weighed against the associated privacy benefits.

Governance. The maintenance of a CBDC may involve the participation of multiple parties, including application developers, hardware manufacturers, cloud service providers, and transaction validators. It is important to ensure that these parties have well-designed guidelines for managing operations and conflicts. In addition, all parties should be incentivized to behave correctly and reliably. For example, in the case of distributed transaction validation pipelines, validators should be incentivized to validate transactions promptly and correctly (e.g., in the order they were received), and there should be clear policies in place for managing unfulfilled commitments.

Layers of the technical stack