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Is a New Economic Crisis Coming?

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As a country that has experienced a number of harsh economic shocks throughout its history, Russia constantly lives in anticipation of a new crisis. Recently, however, economists and investors around the world have been actively discussing the possibility of a crisis as a fairly likely scenario in the near future. Are there any real grounds for these discussions? And what might the consequences for Russia be?

Objective and Subjective Problems of Global Economy

The three main global economic powerhouses – the United States, the European Union and China – are all currently facing serious (albeit different) problems.

At first glance, it would appear that the U.S. economy is in excellent shape: GDP has been growing faster than the average for developed countries over the past several years, unemployment is low and continues to decline, and the stock market keeps setting new records. However, everybody agrees that this positive phase of the business cycle has lasted for too long and should end soon for objective reasons. A similar situation was observed in the United States in the mid-2000s, which gave rise to a popular optimistic belief in the omnipotence of macroeconomic policies that make it possible to overcome the cyclic nature of economic dynamics. These illusions were dispelled by the “Great Recession,” the most significant global financial crisis since the Great Depression of the 1930s. Nowadays, most economists believe that the current steady growth has been stimulated by measures (from the milder monetary policy to efforts aimed at bringing jobs back to the country) whose flipside is sure to manifest itself soon.

The EU economy has yet not fully recovered from the aftermath of the Great Recession. One unpleasant development that Europe has faced in 2019 has been the evident slowdown in the GDP growth of Germany, which has been pulling the European economy forward for several years.

China’s economy has been slowing down for many years now, even though its growth rate remains relatively high at over 6 percent annually. A number of serious problems are worsening against this background, such as excessive corporate debts (of at least 260 per cent of GDP); the spread of “zombie companies” which are effectively non-competitive but are artificially kept afloat for the sake of the jobs they provide and their formal contribution to manufacturing; and signs of a cyclical slowdown. In addition, some experts believe that if the United States keeps true to its threat to introduce import duties on Chinese commodities, China stands to lose a hefty sum of between 0.5 percent and 1.0 percent of its GDP.

Given that the three economic powerhouses account for over one half of global production and play a defining role in the financial markets, the aforementioned problems alone are cause enough to be concerned about the stability of the global economy. Under current conditions, the danger is aggravated by the fact that problems experienced by each of the three giant economies instantaneously spread across the world and hit everyone including even the most remote countries. In better times, this globalization trend may be positive, as each individual economy’s growth generates a demand for the products of other countries, thus stimulating global production. However, in anticipation of an economic recession, the situation resembles a ship with all its bulkheads removed, so a breach in any of its compartments may sink the entire ship.

In addition to the abovementioned objective challenges, there are also artificial problems that arise from discord between the economic giants. The global leaders have recently been actively exchanging threats and blows. This process is mostly down to the behavior of the United States, which is trying to reinstate what it views as fair rules of the game in the world economy. The list of Washington’s demands, primarily of China, is long: dismantling unjustified barriers to U.S. commodities, observing intellectual property rights, switching to a market-based exchange rate of the yuan, and so on. The resultant trade and currency wars hamper mutually beneficial trade while also (and more importantly) making the economic situation less predictable and therefore very risky. This, in turn, leads to a decline in trade, investment, and production.

The main instrument that central banks use to mitigate the negative effects of fundamental factors and “economic wars” is to ease monetary policies. However, in the current situation, this brings only limited results: history tells us that an economy may react positively to switching from restrictive to stimulating measures, but its reaction to a further easing of an already mild policy is very insignificant. In addition, carrying on with excessively mild monetary policies for any protracted period of time robs central banks of their last available ways to kick-start the economy should it grind to a halt.

It is difficult to predict exactly when the current relatively favorable situation in the global economy will worsen dramatically. A year ago, many economists confidently stated that a new crisis would break out in the first half of 2019. The date was later moved back to the second half of this year, and now experts are talking about 2020. This does not mean that the forecasters are not competent enough to make such predictions, rather than the issue is objectively complex.

First, investor behavior is subject to changing moods and “herd behavior.” So-called “self-fulfilling prophecies” play a key role in crisis mechanisms, when crises develop more as a result of the expectations of market players than due to real circumstances. In the face of danger, investors become particularly wary of any early signals in order to switch to safe assets before share prices fall. In general, we may assume that a new crisis could emerge very swiftly, suddenly, and come from an unpredictable direction.

Second, and no less importantly, economic leaders are guided by a range of diverse motives, which makes their behavior difficult to predict. It appears that in its trade disputes the United States is not only protecting its immediate economic interests but also fighting to secure its role as the leader of the global economy in a situation when China has already overtaken it in terms of GDP incomparable prices (in terms of purchasing power parity). On the other hand, President of the United States Donald Trump has to take the upcoming presidential election into account: he cannot afford to see the stock market plummet ahead of the polls.

Given the existing conditions, we may assume that the current relatively tranquil and favorable state of the global economy will most likely worsen considerably in the next 18 months to two years. In fact, this could happen much earlier, but the probability of such a scenario is considerably lower. Let me put it this way: in my opinion, the chances of the “bad times” happening within the next six months do not exceed one to five, even though such a development cannot be absolutely ruled out.

The next question is what form these “bad times” will take: that of a relatively benign “soft landing” or of a “hard-landing.” In the former case, we should expect a slowdown of the global economy and trade, a drop in stock markets, and capital flight to the most stable or trusted countries. In the latter case, the consequences may prove much more serious, including a global GDP slowdown, a series of defaults and bankruptcies and skydiving prices of raw materials.

As things stand, the “soft-landing” scenario appears more probable, at 60/40.

Consequences for the Russian Economy

Formally, the Russian economy appears to be prepared for a crisis. Russia has a relatively low public debt, significant gold and foreign currency reserves, and a budgetary “safety cushion” in the form of the National Wealth Fund. Coupled with a significant double surplus (a positive external balance plus a surplus budget), this gives the country a safe margin of macroeconomic safety. However, practice indicates that such a margin may mitigate the consequences of economic shocks, but does not eliminate them entirely.

Russia was able to use its reserves during the 2008–2009 and 2014–2015 crises, which helped to considerably mitigate the social consequences of the recessions. This is in stark contrast to the 1998 crisis when such reserves were virtually unavailable to the state. In 1998–1999, real average wages in the economy shrank by nearly a third and pensions dwindled by over 40 percent. This contrasts with 2009 when income losses proved much smaller and the level of pensions even grew. At the same time, despite Russia’s available macroeconomic reserves, production volumes noticeably declined in the course of the latest two crises. This can be explained by insufficient levels of confidence among the business community: in crisis situations, business relies on itself and, until the situation becomes clear, lowers investments and reduces discretionary expenses on materials and components.

On the whole, given that external turbulence affects the Russian economy through two main channels (through trade, which is affected by declining prices of oil, gas and metals and by shrinking demand for all exports; and through finance, which is affected by an increase in net capital flight), we may predict that a global economic recession or crisis will result in a slowdown of Russia’s GDP, a slump in the rouble exchange rate, a hike in inflation and a reduction in real incomes. Employment will suffer to a lesser extent: the Russian labor market is rather flexible, which allows for minimal layoffs and subsequent fast recovery of employee numbers. Unlike Greece and Spain, where unemployment hit 27 percent and 26 percent, respectively, after the Great Recession and currently stands at 19 percent and 15 percent, respectively, unemployment in Russia during the same period only grew to 8 percent and declined to below the pre-crisis level by 2012.

The consequences of external shocks grow ever weaker for the Russian economy over time, as the country is improving the quality of its macroeconomic policy (including thanks to the 2014 transition to a floating exchange rate). That said, much still needs to be done if the Russian economy is to become even less dependent on external factors:

  1. Diversify industrial production by reducing the share of raw materials in exports.
  2. Improve the real ability of the real sector to react to market pricing signals in order to take full advantage of the lower exchange rate;
  3. Increase the confidence of businesses in the current economic policy.

Of course, these targets can only be achieved in the long term.

From our partner RIAC

Head of the Economic Expert Group, member of the Economic Council under the Russian President, RIAC expert

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Corporate Tax Havens

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We’ve all heard the term in the media, or tossed around by savvy financial planners or accountants. But what are corporate tax havens? Are they legal? And can they help you reduce your tax liability?

Read on to learn more…

What is a Corporate Tax Haven?

In lay terms, a “tax haven” refers to any jurisdiction or country that offers minimal or substantially reduced tax liability to foreign businesses and individuals.

These so-called havens typically place an emphasis on privacy, sharing little to no financial information with other foreign tax authorities, and often do not require residency or a physical business presence within their borders for a business or individual to benefit.

Criteria to Qualify as a Tax Haven

Interestingly, there are a number of qualifying factors that a jurisdiction must meet in order to qualify as a tax haven. The OECD (Organization for Economic Cooperation and Development), in 1998, offered a number of criteria that could be used to identify such financial centers worldwide.

Tax Haven Characteristics:

  • Zero, or minimal imposed tax on income
  • Privacy standards and no exchange of information with other parties
  • A lack of transparency (to improve privacy/anonymity)

What do Governments Have to Gain?

Tax havens are certainly attractive to investors, business professionals, and wealthy individuals. But what do governments stand to gain by establishing their jurisdiction as a tax haven?

Turns out tax havens have a lot to gain as well.

Benefits of Tax Havens for Countries and Governments:

  • Despite the name, tax havens aren’t typically “free” of cost or fees. Although favorable from a tax liability perspective, they often charge a nominal tax rate while making up for fees in other areas such as high import duties.
  • Registration fees and annual renewals. Some tax havens charge fees for registration, annual licensing and other fees.
  • The attraction of foreign investors and money brings with it a vital infusion of capital into the local economy. Further, the country may benefit from ongoing business operations within its borders, such as investments in local infrastructure, offices, job opportunities and more.

As you can see, there are a number of built-in incentives for a government to operate a tax haven, including capital injection into the country’s economy where investments may flow into local businesses, financial institutions, and other vehicles.

Key Tax Haven Benefits

International tax havens have long been the preferred domicile for Fortune 100 companies, astute investors and privacy-minded individuals. But why?

1. No (or minimal) Tax Liability

As the name clearly suggests, these domiciles are havens for corporations, individuals and investors seeking to reduce their tax liability. Many developed countries have implemented a “progressive” tax system that places an increasing burden on those with higher income.

International tax havens offer a clear path to minimizing taxes safely and effectively, with many locales having zero corporate taxes, capital gains tax, personal income tax and more.

2. Privacy and Discretion

Corporate tax havens offer more than just tax savings. These locations boast unmatched privacy for individuals and corporations alike. Many tax havens accomplish this by not keeping any publicly accessible bank account or company information, and policies preventing them from sharing any recorded information with outside third parties (such as international tax agencies). For example, in Antigua and Barbuda, it is actually illegal for a bank to disclose account holder information to any third party. Interestingly, not even Antigua and Barbuda’s own government can access this information.

3. Security and Peace of Mind

International tax havens often play by their own rules, outside of the jurisdiction of (sometimes) overbearing nations such as the United States or the governing bodies of the EU. This level of independence can be a major benefit for individuals who have concerns about their privacy and outside governmental agencies such as the IRS, FAFT, OECD, and others overstepping their bounds.

Furthermore, most corporate tax havens do not participate in what are known as TIEAs or “Tax Information Exchange Agreements” with the EU or USA.

This means that even if outside organizations try to investigate or uncover information, there is no legal framework in place to allow them to do so.

4. Convenience

For those seeking alternative locales to do financial business, corporate tax havens are attractive options due to their simplicity and well-defined processes for setting up new accounts. In fact, due to their business-friendly legislation, getting set up with many tax havens can take as little as 2-4 days. Not to mention business registration is typically low, with many jurisdictions charging $500 or less and can be done all without even visiting the country.

But that’s not where the convenience factor ends. In an effort to attract more business, many corporate tax havens work to make the process of running and managing a business within their domicile as easy as possible. This typically manifests as less paperwork and administration.

Highlighted Tax Havens

The number of popular tax havens is extensive. Below we’ll highlight two popular corporate tax haven destinations.

1. Malta

The nation island of Malta is a member state of the EU (European Union), a key reason why Malta passports are highly sought after around the world. Malta is a safe country, rich in culture and strategically located between Africa and Europe. Their program, simply named Malta’s Individual Investor Program (MIIP) is a popular option for many investors worldwide.

Malta’s Individual Investor Program (MIIP) Requirements:

  • Contribution of €650,000 to the National Development and Social Fund
  • Contribution of €25,000 for minor children and a spouse of the primary applicant
  • Contribution of €50,000 for each dependent child age 18-26 or dependent parents age 55 or older
  • Due diligence fees
  • Residence in Malta for 5 years
  • Purchase of property valued at €350,000 or lease a property at €16,000 or more per month
  • €150,000 deposit in a government-approved financial instrument

Benefit of the Program:

  • Advantageous tax system
  • Tax concessions
  • Centralized business hub
  • Tax treaties with over 50 countries
  • English as the primary language of business
  • Access to free EU healthcare and education systems
  • Malta passport opens up visa travel to over 160 countries
  • Stable and safe country
  • Lifetime citizenship can be passed to future generations

2. Saint Kitts and Nevis

The duel island nation, also sometimes referred to as the Federation of Saint Christopher and Nevis, represents one of the most popular corporate tax havens. Known for its charming islands and beautiful backdrop, the two offer what is known as the St. Kitts and Nevis Citizenship by Investment Program. This program, established in 1984 is the longest-running economic citizenship program worldwide.

Benefits of the Saint Kitts & Nevis Citizenship Program:

  • Passport can be obtained within 6 months
  • Enjoy citizenship in a Commonwealth country
  • Dual citizenship is allowed
  • Enjoy visa-free travel to more than 168 countries
  • No physical residence required
  • No education, test or interview requirements
  • No tax on worldwide income
  • Full citizenship for life that can be passed on to future generations

3. Other Popular Corporate Tax Havens Include

  • Bermuda
  • Netherlands
  • Bahamas
  • Cayman Islands
  • Luxembourg
  • Isle of Man
  • The Channel Islands
  • Singapore
  • Mauritius
  • Ireland
  • Switzerland

Closing Thoughts

Corporate tax havens provide a myriad of benefits for those businesses and professionals seeking to reduce their tax liability, increase privacy, obtain second citizenships/passports and more. These benefits are key drivers for so many corporations, large and small, to seek out these domiciles for their business and investments. With proper due diligence and planning, you too can take advantage of all these havens have to offer.

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Banking on action: How ADB achieved 2020 climate finance milestone one year ahead of time

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As they extend their power grids, build more roads and bigger cities, and cultivate forestland, developing countries in Asia and the Pacific are increasingly contributing to the global climate change problem. Two of the top three emitters of greenhouse gases are developing countries in Asia—the People’s Republic of China and India. At the same time, five Asian developing countries are among the top 10 most climate-vulnerable countries in the world. Across the region, livelihoods and economic growth are increasingly exposed to climate change impacts and disaster risk. Clearly, Asia and the Pacific must play a strong role in efforts to address climate change.

As the region’s development bank, the Asian Development Bank (ADB) is committed to remaining the partner of choice for climate action by our developing member countries. In 2015, as world leaders gathered in New York to launch the Sustainable Development Goals, ADB made a bold announcement—a commitment to double our climate investment to $6 billion annually by the end of 2020.

Coinciding with the call for action at COP25, the United Nations’ Conference on Climate Change, ADB has proudly reached this achievement one year ahead of time. ADB’s climate-related financing for 2019 comprises $1.4 billion for financing adaptation and $4.8 billion for mitigating climate change.

The feat is the result of a singular focus to integrate climate actions into our entire operations. ADB has introduced climate risk screening of our project portfolio, undertaken diagnostics on the critical infrastructure at risk in the region, and introduced new financing instruments such as contingent disaster risk financing for financial resilience. ADB  is strengthening its investments in renewable energy and energy efficiency, sustainable transport and urban development, and climate smart agriculture. This has been accompanied by actions to enhance the transparency of our climate operations by publicly disclosing project-level information of our climate portfolio and enhancing capacity and technical assistance for delivery. The spirit of One ADB has underpinned this achievement, with the collaboration of our sovereign and non-sovereign operations and knowledge departments steering us toward this target. One example of the many that illustrates this is the Pacific Renewable Energy Program, which is providing an innovative blend of loans, guarantees, and letters of credit to encourage private sector investments in renewable energy. ADB’s treasury department also contributed to the endeavor by issuing green bonds amounting to $5 billion as an added financing mechanism.

In addition to scaling up its own climate financing, ADB has been working on new and innovative co-financing opportunities with public and private partners. For example. ADB has mobilized concessional financing from the Green Climate Fund (GCF) for nine projects worth a total of $473 million in grants and concessional financing.

Building on the momentum of our climate finance milestone, ADB is pursuing new and ambitious targets on climate change for the coming decade in our Strategy 2030—cumulative climate financing of $80 billion from 2019-2030 and a commitment to make 75% of our projects climate-relevant by 2030. Furthermore, by  steadily increasing shadow carbon price, which factors climate costs into our project economic analysis, ADB is reflecting the urgency of shifting to low carbon alternatives.

However, given the narrowing window for avoiding catastrophic climate change, mobilizing finance at the necessary speed and scale remains a huge challenge. The Nationally Determined Contributions of many countries have outlined the financing needed to achieve their climate ambitions under the Paris Agreement. According to one estimate, it is $4.4 trillion or $349 billion annually[1]. While there are no robust and comprehensive estimates available for the Asia and Pacific region, an assessment by ADB on Asia’s infrastructure needs found that $200 billion will be needed annually to address climate actions in energy, water, and transport[2].

Though national governments and development financing institutions should devote more of their financial resources, the bulk of climate financing will necessarily have to come from private investors. This highlights the need to deploy climate financing in a way that enables and mobilizes private sector finance. But the good news is there is a robust, and growing, body of evidence that the benefits of climate action already far outweigh the costs—representing a significant opportunity for the private sector. For example, the New Climate Economy Initiative, to which I have contributed as a Commissioner, has found that investment in low-carbon growth is associated with a cumulative economic gain of $26 trillion until 2030. Meanwhile, a recent report by the Global Commission on Adaptation found that investing $1.8 trillion globally from 2020 to 2030 in five key areas—early warning systems, climate-resilient infrastructure, improved dryland agriculture, mangrove protection, and more resilient water resources—could yield $7.1 trillion in net benefits.

The provision of finance is just one part of the climate change puzzle—high technology, policy support, and capacity development to build better institution are also critical. But by further scaling up collective actions on addressing climate change by national governments, development partners, and the private sector, we can greatly respond to the voices of younger generations and vulnerable populations across the world for bolder action that ensures our common future on a healthy planet.

  ADB

[1] L. Weischer et al. 2016. Investing in Ambition: Analysis of the Financial Aspects in (Intended) Nationally Determined Contributions. Briefing Paper. Germanwatch e.V. and Perspectives Climate Group: Bonn. https://germanwatch.org/en/download/15226.pdf

[2] ADB. 2017. Meeting Asia’s Infrastructure Needs

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The Yuan versus the Dollar: Showdown in the Global Financial Arena

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At the 1944 Bretton Woods Conference, the United States laid the foundation for the U.S.-centric international monetary system, thus ensuring the dollar’s status as the key reserve currency for the next 75 years. The fact that other countries accepted the dollar as the main currency of international payments, loans and investments allowed U.S. transnational corporations to dominate global markets in the post-war period quickly. However, if we are to proceed from the development patterns of the international monetary and financial system, then it follows that the dollar will eventually be replaced by the yuan, the currency of the new global economic and financial leader (China). Will Beijing manage to build its own system of global institutions, one that is capable of internationalizing the yuan and competing against the U.S. currency when it comes to servicing global flows of commodities and finance? In order to answer this question, we need to look at the trends of the global financial architecture as it stands today and identify the strengths and weaknesses of the U.S. and Chinese financial systems.

The Global Financial Architecture

The global financial architecture (GFA) is the combination of institutions involved in the regulation of global finance. It consists of a model for organizing international financial relations, institutional mechanisms for managing these relations, and the principles underlying the participation of countries in decision-making processes. The GFA model is based on the competitiveness and openness of global financial markets. The institutional mechanisms include fiat (intrinsically valueless) money, the free trans-border movement of capital and a system of floating exchange rates. The influence of individual countries on the development of the GFA depends on the size of their quotas and votes within the Bretton Woods institutions of the IMF and the World Bank.

One feature of the current transformational processes as applied to the GFA is the concentration, in individual countries, of financial assets that exceed the size of their economies by tens, hundreds and even thousands of times. For example, the financial assets controlled by Luxembourg exceed its GDP by 248 times, and those of the Cayman Islands exceed its GDP by 1861 times. These imbalances are caused by the fact that the modern GFA is formed not along the lines of the formal Bretton Woods institutions, but rather informally, via the offshore financial system.

It is in offshore jurisdictions, i.e. outside the national borders of the countries that issue international currencies, that the bulk of global monetary liquidity is generated. For example, in 2007–2008, the Federal Reserve Bank of New York opened temporary dollar swap lines for the central banks of 14 countries worth over $10 trillion to refinance the dollar liabilities of lending institutions operating out of those jurisdictions. The swap lines were discontinued in February 2010, but were reinstated three months later in a different format between the Federal Reserve System (FRS) and five key central banks that are closely linked to the United States: the European Central Bank, the Swiss National Bank, the Bank of England, the Bank of Japan and the Bank of Canada. These C6 swap lines were made permanent and unlimited in October 2013. It is thanks to these currency swap operations that the U.S. FRS can create euros, pounds and yen in offshore jurisdictions. The other countries involved can participate in the creation of offshore U.S. dollars. The massive swap agreements involving the most significant central banks undermine the importance of the Bretton Woods institutions as the providers of global liquidity and make it difficult to record and control global capital flows at the intergovernmental level.

The U.S. Financial System

The main strength of the U.S. economy is that it issues the key global currency, as well as the fact that it has created the world’s biggest stock market, in which more than half of all U.S. households participate. The United States has the most liquid bond market, which means that the dollar is the international benchmark for value and the main reserve asset for the rest of the world (its share in the international reserve portfolios of central banks exceeds 60 per cent). Over 50 per cent of all international deposits, loans and promissory notes are nominated in U.S. dollars. Washington is home to the headquarters of the Bretton Woods institutions, which are responsible for macroeconomic oversight and addressing structural imbalances in the 189 member nations. Three U.S. rating agencies account for 96 per cent of all credit ratings assigned in the world, U.S. investment holdings manage more than 50 per cent of global corporate assets. These and other factors explain the dominant role of the United States in the formation and development of the GFA.

The main weakness of the U.S. financial system is that the country’s economy is based on debt and is extremely dependent on bank lending terms and the dynamics of stock market operations. A sharp increase in interest rates or a decline in demand as a result of economic overheating leads to a nosedive in share prices, which, in turn, leads to a depression, as was the case in 1929 and 2008. One other vulnerability of the U.S. financial system is its dependence on external financing, which is due to the status of the dollar as the key reserve currency. Should the international demand for dollars decline, U.S. funding from external sources may also decrease.

China’s Place in the GFA

China leads the world in terms of monetary aggregates (in the dollar equivalent), purchasing power parity GDP, production and exports, and the labour force size. However, China’s economic growth continues to be largely dependent on imports of foreign investments and technologies.

China’s leading positions on a number of economic indicators still has a negligible effect on the country’s ability to influence international financial relations. As before, the head of the IMF is a European citizen and the head of the World Bank is an American. Unlike other international organizations within the UN system, which make decisions based on the “one vote per country” principle, the IMF and the World Bank are stock companies whose capital is owned by the member nations. Decisions on the most critical issues on the agenda of the Bretton Woods institutions are made by a qualified majority of 85 per cent. Following the reform of the IMF quota and voting system in 2010–2016, the BRICS countries failed to gain the minimum number of votes (15 per cent) to obtain veto power and assert the multipolar principle within the organization. Just like before the reform, the United States continues to be the only IMF member nation that has the power veto.

China certainly owes much of its global economic achievements to its membership of international financial and economic organizations that the United States was instrumental in founding and running. That said, in order for China to protect its economic interests in an effective manner and exert tangible influence on decision-making processes in the global economy, Beijing needs to participate in those international institutions in which its vote has a decisive role. In this sense, China has high hopes for its recent initiatives to create pan-Asian institutions for monetary policy, finance and economics, such as the BRICS Contingent Reserve Arrangement, the Chiang Mai Initiative Multilateralisation, the BRICS New Development Bank and the Asian Infrastructure Investment Bank.

The opening of the Shanghai International Energy Exchange (where transactions are carried out in Chinese yuan) on March 26, 2018, was a particularly significant event. This was China’s first step towards the formation of a “petroyuan” pricing system on the global energy resources market. The Shanghai Futures Exchange has begun trading in new oil futures, known as INE, which are expected to compete against British Brent and U.S. WTI contracts. The pricing of oil in yuan is an important component of the drive to internationalize the Chinese currency and lessen the global economy’s dependence on the dollar.

By late 2017, the People’s Bank of China had signed 37 swap agreements with different countries worth more than 3 trillion yuan. The agreements were aimed at facilitating the use of the yuan in doing business with foreign banks and companies, so that the central banks receiving liquidity in yuan can act as lenders of last resort after the activation of currency swap lines. However, the agreements have not resulted in a significant increase in the global use of the yuan, which is what was originally expected. Since the 2008 initiation of the swap agreements, the share of the Chinese currency in the denomination of international promissory notes has stood at roughly 0.3 per cent, whereas the share of the U.S. dollar has grown from 47 per cent to 63 per cent.

In addition, currency transactions involving the yuan are mostly done via London, not Beijing. The United Kingdom accounts for 33.79 per cent of all global currency operations involving the yuan. Hong Kong remains the largest clearing centre for international transactions in yuan, serving 76.36 per cent of all such global operations (the United Kingdom is second with 6.18 per cent). Thus, most international transactions involving the yuan are performed outside continental China.

One more obstacle to the faster internationalization of the yuan is China’s preoccupation with domestic problems stemming from the rapid growth of debts (especially in the property market), the growth of the shadow banking system and the disproportionate allocation of loans to large and small businesses. In its attempts to conduct a softer monetary policy, the Chinese government is facing a difficult choice between supporting short-term growth and countering unfavourable external shocks. A monetary easing could increase the vulnerability of the Chinese economy, because continued lending growth is capable of slowing down or complicating the restoration of banks’ balance sheets and aggravating the existing imbalances in the allocation of loans.

University of California professor Barry Eichengreen, who is one of the most respected experts on the development of the international monetary system, says the yuan does not qualify as an international currency for three reasons: 1) the high costs of financial transactions involving the acquisition and distribution of information; 2) China’s great dependence on Hong Kong as a regional offshore centre; 3) China’s inability to exert political pressure on the other global economic centres, primarily the United States and the European Union. At the same time, according to Eichengreen, there are four factors indicating the growing status of the yuan as a regional currency: 1) the potential growth of incomes in Asian countries, which results in increased demand for Chinese commodities; 2) the implementation of multilateral projects as part of the Belt and Road initiative, which results in the growing use of the yuan in Central and Southeast Asia; 3) the development of the Asian bond market, which leads to the standardization of international promissory notes nominated in yuan; 4) the growing demand for yuan on the part of commercial banks and companies in swap transactions between central banks as part of the Chiang Mai Initiative.

Points of Conflict between the United States and China

Unlike the Cold War era, which was characterized by the polar confrontation between two systems, today the United States and China are members of the same international financial organizations, they both interact in the uniform global capitalist market and follow the same principles of competition, effectiveness and profit maximization. For this reason, the main point of conflict between the United States and China concerns mutual restrictions when it comes to allowing the other country’s finished products and services onto their national markets.

Nobel Memorial Prize in Economic Sciences recipient Joseph Stiglitz believes that the United States stands to lose more from its trade war with China than China does, as the Chinese authorities have far greater opportunities to restrict the operations of U.S. corporations working in China than the U.S. authorities do when it comes to Chinese goods imported into the United States as part of international trade. In addition, raising the prices of Chinese commodities on the U.S. market may cause dissatisfaction among end customers.

Another point of conflict between the two countries is connected to China’s limited ability to influence major international organizations. Despite the IMF reform, China did not secure a tangible increase in its influence within the organization, with its quota only growing from 4.0 per cent to 6.41% per cent. We should note here that when the IMF began operating in 1947, China’s quota was bigger than it is now, at 6.56 per cent (even though the country was the world’s fifth-largest economy at the time, not the second largest as it is today). The formal inclusion of the yuan in the special drawing rights (SDR) basket (the IMF’s cashless reserve asset) in 2016 was largely symbolic, because the use of SDRs has no effect on the actual balance of forces in the GFA. The value of the SDRs in circulation stands at $204.1 billion, or under 4 per cent of the international currency reserves calculated in dollars. The share of the yuan in the structure of international currency reserves and international transactions stands at approximately 2 per cent, which does not reflect China’s global role as the largest manufacturer and exporter.

One more potential point of conflict is the development of artificial intelligence (AI) technologies. In accordance with the Made in China 2025 plan to develop strategic technologies, the country expects to have assumed global dominance in the world in the field of AI by 2030. The financial sector has high hopes for AI in terms of its potential to increase effectiveness and profitability, much like the effect that the introduction of information technologies had on financial services. China has already outstripped Europe in the number of AI-related startups and is gaining ground on the global leader in AI, the United States.

Conclusions

Experts view pan-Asian financial institutions as an instrument used by China to establish its status as the leading Eurasian and global power. Chinese officials repeatedly stress that the newly established institutions aim to compete with the Bretton Woods institutions, not replace them. In other words, at the current stage in the development of the GFA, China has no intention of changing the neo-liberal principles of its functioning.

Despite the significant increase in China’s influence on the global economy and the addition of the yuan to the SDR basket, the dollar continues to play the key role in the global financial market and in servicing international trade in commodities and services. China’s growing influence on the GFA thus depends on strengthening the global role of Sino-centric financial institutions and on the broader use of the yuan in international payment systems and in transactions on the global financial market. At the same time, the active creation of offshore dollars that are not controlled by the U.S. regulators increases the risk of the dollar-centric currency system collapsing.

It is obvious that the current GFA configuration is not likely to undergo any significant changes in the foreseeable future (unless another global financial crisis breaks out) because the United States has a significant number of institutional instruments and mechanisms for influencing the global economy at its disposal. In the long run, however, any growth in China’s actual role in the international financial system will depend on the successful promotion of a conceptual alternative to the current GFA model for the purpose of overcoming global imbalances between the financial sector and real economy.

From our partner RIAC

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