Year: 2020

Hacking away at the system

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To the outside world, Kim Hyon Woo was a developer working for Chosun Expo Joint Venture, a China-based company that supplies freelancing software development and gambling-related products. But in reality, Kim didn’t exist. The person who controlled his email accounts – a man named Park Jin Hyok – was born and educated in North Korea.

Chosun Expo was also not what it seemed. As a matter of fact, it was a front company for Lab 110, a top-secret arm of the Democratic People’s Republic of Korea’s (DPRK’s) military intelligence agency. When Chosun Expo wasn’t carrying out normal business operations, it was facilitating some of the world’s highest-profile cyberattacks, including the Sony Pictures hack of 2014 and the WannaCry ransomware attack of 2017, the latter of which affected more than 200,000 systems across 150 countries and crippled hospitals in the UK, ultimately costing the National Health Service £92m ($117.3m).

It’s estimated that the value of attempted cyber heists conducted by Park and his co-conspirators between 2015 and 2018 amounted to $1bn. Eventually, connections to Kim’s email addresses revealed Park to the FBI. “The scope and damage of the computer intrusions perpetrated and caused by the subjects of this investigation, including Park, is virtually unparalleled,” Nathan P Shields, a special agent with the FBI, concluded at Park’s trial.

The WannaCry hack was one of the costliest cyberattacks in history, but represented just one of the numerous incidents that alerted the international community to the growing sophistication of North Korea’s hackers. Now, recent reports indicate that cyberattacks have become more than a form of warfare for North Korea: they are also a key source of income for Kim Jong-un’s brutal regime.

 

A money-spinner
According to a report presented to the UN Security Council Sanctions Committee on North Korea, the authoritarian state generated approximately $2bn from cyberattacks between 2016 and 2019 – a significant amount, considering the country’s GDP was worth an estimated $18bn in 2019 (see Fig 1). These funds were subsequently funnelled into the DPRK’s military.
“The US Government has released reports affirming that the funds are being spent on weapons of mass destruction and ballistic missiles programmes,” Kathryn Waldron, a fellow at the R Street Institute who focuses on cybersecurity, told World Finance. “Experts have also speculated that some of the funds may go to supporting the Kim family’s opulent lifestyle, as well as other government programmes.”

North Korea has a long history of bringing capital into the country via illicit means. Since the 1970s, the country has engaged in the manufacturing, selling and trafficking of drugs such as methamphetamine – not to mention the production of counterfeit currency. According to the Congressional Research Service, a dollar-counterfeiting operation made North Korea about $15m per year at its peak.

Many academics hold that these operations have long been a core revenue stream for the state, with Robert Collins, Bruce Bechtol and Paul Rexton Kan calling the regime’s practices a form of “criminal sovereignty” in their book of the same name. Cybercrime is the latest of these moneymaking endeavours, and the UN’s report suggests it could become the most financially lucrative so far.

But this was not always the case: not long ago, analysts scoffed at North Korea’s cyber capabilities. Its distributed denial-of-service (DDoS) attacks in 2009 only temporarily shut down South Korean websites and ultimately did little damage. Attacks like this were ideologically motivated and primarily intended as acts of cyber warfare. It’s only in recent years that the nation has begun harnessing its cyber capabilities with the specific intention of generating funds.

“Right now, most of their attention seems to be on using the full range of what is possible in cyberspace to generate as much foreign currency as possible,” Jenny Jun, a PhD student in the Department of Political Science at Columbia University, told World Finance. In September 2018, cybersecurity research firm FireEye uncovered the existence of a specific unit in North Korea’s cybercrime group – Lazarus Group – that seemed to be dedicated specifically to financial crime. This same group was behind the Bangladesh Bank cyber heist of 2016, which saw at least $81m stolen by North Korean actors. In the same attack, North Korea came within a hair’s breadth of stealing $1bn from the US Federal Reserve – the only reason it didn’t succeed was that the bank spotted a spelling mistake in one of the transactions.

Today, there are myriad ways that North Korea uses its cyber operations to generate revenue beyond attacks on financial institutions. “[North Korean] cyber activity includes everything from stealing from cryptocurrency exchanges, fraudulent SWIFT transactions [and] ransomware [to] blackmail with exfiltrated data, ‘cryptojacking’ and hackers for hire,” Jun explained. As North Korea’s cyber heists have become more sophisticated and costly, the international community has raised its threat level and response, especially the US (see Fig 2). In April, the US Government announced it was offering $5m for information on hackers – an unusual step for the nation and a sign that the cyberthreat posed by North Korea is now widely recognised on the international stage.

“North Korean hackers pose a serious threat to the global financial system,” Waldron said. “We’ve seen North Korean hackers engaged in a wide variety of malicious cyber activity within the global financial system, including holding data for ransom, stealing cryptocurrency and even using malware to make fraudulent ATM withdrawals.”

 

Dodging sanctions
North Korea’s cyber prowess may seem improbable for one of the poorest and most cut-off countries in the world, where only the elite have access to the internet, but analysts believe it has finessed a formula for recruiting young cyber prodigies. “It is believed that students showing potential are selected at a young age, around middle school, to enter into a special training programme,” Jun explained.

Cyberattacks have become more than a form of warfare for North Korea: they are also a key source of income

The state then funnels them into one of two universities: either Pyongyang’s Kim Il-sung University or Kim Chaek University of Technology. After this, they are sent abroad to Russia or China to strengthen their knowledge of hacking. Broadband is generally cheaper and faster in these countries, which helps North Korea overcome the problem of limited internet access.
North Korea’s hacking elite are well compensated for their training. In addition to receiving food subsidies and a generous stipend for overseas deployments, hackers and their families get the privilege of living in the capital, Pyongyang. Although cybercrime may seem an unlikely mode of operating for the isolated nation, in other respects, it presents itself as the ideal income generator: for one, it’s low-cost. Further, with North Korea far from being fully integrated into the global internet infrastructure, the country is surprisingly invulnerable to retaliation. Cybercrime also softens the economic blow of North Korea’s exclusion from the global financial system: without sufficient income from trade, illicit cyber activities become a vital stream of wealth for the state and enable North Korea to evade international sanctions.

The state has faced multilateral sanctions from the UN ever since 2006, when North Korea carried out its first nuclear test. Initially, these sanctions focused mainly on weapons-related goods, but gradually they were expanded to include luxury goods to target the elite. For the first decade, sanctions were thought to have little impact on North Korea. But since 2016, US President Donald Trump has championed a “maximum pressure” campaign that places caps on energy imports, bans exports of minerals and textiles, and prohibits the granting of new permits for overseas North Korean workers. Although it’s difficult to measure the exact impact of these sanctions, given how limited North Korea’s economic data is, the Bank of Korea in Seoul estimates that the state’s annual GDP fell by 3.5 percent in 2017 as a result.

North Korea has always sought to dodge sanctions using its smuggling networks. In 2017, the DPRK earned about $200m from banned exports of coal and arms, according to a secret report by independent UN observers. The UN also claimed that it was thanks to a covert shipping network that North Korea avoided gasoline and diesel fuel shortages in 2019. More recently, North Korea has used cryptocurrency to fund these illicit trade networks.

 

 

By any means necessary
The use of virtual tokens like bitcoin makes the movement of money and goods across borders much harder to detect. “Cryptocurrencies enable North Korea to carry out illicit [activities], primarily because [these coins], by nature, are used outside of the formal financial system,” Kayla Izenman, a research analyst at the Royal United Services Institute’s Centre for Financial Crime and Security Studies, told World Finance. “This means that North Korea avoids interacting with financial institutions, [which] are quite advanced in tracking illicit activities, and instead either bypasses centralised intermediaries (such as cryptocurrency exchanges) entirely or uses ones with low or no compliance processes in place.”

In March 2019, a UN panel estimated that North Korea had amassed $670m in virtual and fiat currency – largely by stealing it. Although North Korea denies such activities, it is widely thought to have successfully targeted Asian cryptocurrency exchanges at least five times from January 2017 to September 2018, with losses from these exchanges estimated at $571m.

Izenman believes North Korea’s success in hacking these exchanges indicates a need for more robust security measures: “Despite progress in international cryptocurrency industry regulation and even proactive compliance measures adopted by some exchanges in advance of required regulation in their jurisdictions, some exchanges still do not require much, if any, information on their customers. North Korea has been known to use these exchanges and sometimes even use fake IDs to bypass lax customer due diligence procedures.”

The state’s success in attacking these institutions and exchanges is also a testament to its growing sophistication as a hacking power. “In little over a decade, North Korea has significantly increased its cyber operations capacity [and] diversified its targets, [while] its tools, techniques and procedures have become more sophisticated,” Jun said. “Back in 2009, when North Korea was just beginning to operate in this space, they were doing relatively simple DDoS attacks against foreign websites… By 2014, North Korean advanced persistent threat groups had demonstrated that they have the organisational and technical capacity to compromise and gain admin privileges on a network such as Sony, maintain a persistent presence, demonstrate some creative ways to conduct socially engineered phishing and, finally, understand how to use cyber capabilities to have the most damaging effect on a target.”

However, Jun pointed out that North Korean cyberattacks are still far from flawlessly executed: “Details behind the WannaCry ransomware [attack] also show that they are sometimes sloppy too if the real goal has been indeed to generate revenue and not for disruptive reasons.” For example, the malware used only four hardcoded bitcoin addresses, making it easier for the security community and law enforcement to track any attempt to anonymously cash out WannaCry profits. What’s more, despite the huge amount of damage it inflicted on transport and healthcare systems, the ransomware only made the hackers around $55,000.

But weaknesses in North Korea’s hacking strategy are not necessarily cause for celebration: for every cyberattack that isn’t perfectly executed, one can assume the next will be an improvement.

 

 

A global threat
As North Korean cyber capabilities have grown in sophistication, countries have become more aware of the havoc they could potentially wreak. In an advisory released in April 2020, US officials said that North Korea’s cyber activity poses “a significant threat to the integrity and stability of the international financial system”.

For every cyberattack that isn’t perfectly executed by North Korea, one can assume the next will be an improvement

“I think there’s been a distinct shift in [the] global understanding of North Korea’s cyber power, probably following the Sony hack in 2014 and really increasing in awareness after WannaCry in 2017,” Izenman said. “I’ve found states are generally aware of North Korea’s hacking prowess, but perhaps less aware of the way in which this directly connects to their proliferation financing model. And if they do understand the connection between cyber and financing the regime, they often focus on bank or ATM hacks and don’t realise how much North Korea is gaining in cryptocurrency.”

Some analysts have argued that North Korea’s exclusion from the financial system motivates it to create economic chaos for the rest of the world, but Jun disagrees with this view: “Although I think North Korea has considerable intent and capacity to target financial institutions for monetary gain, I don’t think it is necessarily in their interest to paralyse the global financial system for destructive purposes. They don’t want to kill the chicken that continues to lay eggs.”

Although it may not be North Korea’s intention to deliberately undermine the financial system, this could be an indirect consequence of its more devastating attacks. If the state succeeded in attacking a major financial institution, for example, it could undermine its ability to lend, potentially triggering a financial crisis.

“Events like the Bangladesh Bank heist show that fraudulent SWIFT transactions can be made – which other criminal groups such as Carbanak have also been doing – and more news about such vulnerabilities that can be exploited can lower consumer confidence,” Jun explained. “There is also a broader policy question concerning regulation and oversight over international cryptocurrency transactions.”

North Korea’s exclusion from the financial system motivates it to create economic chaos for the rest of the world

Waldron, meanwhile, warns that the threat from North Korean hackers may be greater now than ever before: “With the global economy reeling from the economic impact of COVID-19, governments, businesses and financial institutions are uniquely vulnerable to the financial costs of a successful cyberattack. And COVID-19 has presented hackers with new cybersecurity vulnerabilities to exploit.

“In many countries, a greater number of government and business employees are working from home. This presents North Korean hackers with particularly vulnerable targets, as many of these employees may not be well versed in cybersecurity. North Korean hackers have also used COVID-19-related material as a trap for unsuspecting victims, such as when they emailed South Korean government officials documents detailing COVID-19 response plans laced with malware.”

Although the international community is now largely in agreement that North Korean cyber activity poses a serious threat, it remains unclear what it should do about it. Sanctions would have little effect – so far, North Korea’s economic isolation has only exacerbated its need for illicit income. “If North Korea secures a steady stream of foreign cash that can be funnelled back into its nuclear and missile programme… the sanctions regime [is neither] effectively going to slow this process nor act as a punishment mechanism to persuade North Korea to denuclearise,” Jun said. “This may alter bargaining dynamics at the negotiation table.”

Negotiation is particularly difficult when the perpetrator refuses to own up to their crimes. When the US issued its warning on the North Korean cyberthreat in April, North Korea feigned ignorance. “We want to make it clear that our country has nothing to do with the so-called ‘cyberthreat’ that the US is talking about,” North Korea’s Foreign Ministry said in a statement. Similarly, when Park was charged, North Korea not only denied his crimes but also called him a “non-existent entity”.

As long as its cyber programme remains financially lucrative, the North Korean state has no reason to admit to its actions. For now, the international community is left with little option but to simply stay vigilant and invest in defences against this growing threat.

A baptism of fire for the new managing director of the IMF

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Kristalina Georgieva was only six months into her role as head of the IMF when the coronavirus pandemic struck. With economies around the world grinding to a halt, many countries found themselves in desperate need of financial aid from the lender of last resort. Since the start of the crisis, the IMF has expanded two emergency loan programmes, and more than 100 countries have applied for support.

Georgieva has warned that the world is headed for a recession even worse than that of the Great Depression, and believes the gravity of the situation demands a no-holds-barred economic response. “Do as much as you can,” she told member states on April 27. “Then do a little bit more.” As well as urging member states to spend whatever was needed to fight the virus, she has eased access to the lender’s emergency $1trn fund and promised that lending programmes were being approved at record speed.

Although the challenge ahead is daunting, her supporters believe she is the perfect person for the job. Georgieva has long been a voice for emerging economies, which, in the current crisis, will be hit especially hard by falling oil prices, capital outflows, the collapse in tourism and decline in demand for exports. “I am worried about countries that, even before this crisis, were in a weaker position,” she said in April. “The same way the virus hits more severely those [who] have preconditions [or] weaker immune systems, the [economic] crisis hits weaker countries much more severely.”

 

Champion of emerging economies
It is no surprise that Georgieva has such an affinity for the world’s poorer nations: born in Sofia, Bulgaria, she is the only IMF leader ever to herald from an emerging economy. Growing up behind the Iron Curtain, Georgieva quickly learned the pain of financial hardship.

Although she came from a prestigious family – her great-grandfather, Ivan Karshovski, played a key role in building the new Bulgarian state following independence from the Ottoman Empire – Georgieva’s youth was far from easy. When her father became seriously ill, she and her family found themselves struggling to make ends meet. The fear of becoming a burden drove her to pursue academic success and taught her the resilience that she’s been applauded for throughout her career. “The tougher life is, the more you smile,” she told the Financial Times in 2017. “Panic? Would it help? No – it drove me to mature much faster.”

Georgieva has always believed that she would be best placed to help Bulgaria by working in an international role, so when Bulgarian Prime Minister Boyko Borisov invited her to become the Commissioner for International Cooperation, Humanitarian Aid and Crisis Response at the European Parliament in 2010, it was an easy decision. “I agreed to become a commissioner because the situation wasn’t good for Bulgaria and there was a possibility of our reputation being hurt,” she said at the time.

Kristalina Georgieva and European Commission President Ursula von der Leyen
Kristalina Georgieva and European Commission President, Ursula von der Leyen

During her time in the role, Georgieva managed one of the world’s largest humanitarian aid budgets and established herself as an advocate for the growing number of crisis-affected people around the world. She then served as the European Commission Vice President for Budget and Human Resources, a role that saw her heavily involved in efforts to tackle the euro area debt crisis. Georgieva didn’t lose sight of her care for marginalised communities, though; in 2015, she tripled the funding available to the refugee crisis in Europe. She was also the driving force of improvements to the commission’s gender representation, helping it achieve its target of filling 40 percent of management roles with women by 2019. “If we don’t have targets, it will take 100 years for women to reach men in salary terms, in terms of their ability to contribute to society,” she told CNBC in 2018. “No community, no society can survive unless we tap into the talents of everybody.”

Georgieva was praised for keeping a cool head during heated debates – in particular, her steady handling of the EU’s incredibly divisive budget impressed her peers. She has demonstrated a capacity to stand her ground while managing politically fraught situations, leading her to become the undisputed candidate for the IMF leadership in 2019, having been the only nominee for the role.

 

Impressive experience
Georgieva’s international career didn’t start at the European Commission. Prior to that, she spent 17 years building a career at the World Bank. Having been recruited as an environmental economist in 1993, she steadily climbed the ranks of the elite international organisation, taking on a number of directorial positions. She returned to the World Bank in January 2017, when she was appointed CEO of the institution. The move from the European Commission back to the World Bank came just months after her unsuccessful bid to become the UN’s secretary-general.

Although Georgieva insisted that her move was not influenced by the internal politics of the commission, those around her claimed she had repeatedly butted heads with Chief of Staff Martin Selmayr. Politico reported at the time that Georgieva saw Selmayr as a “poisonous” influence who failed to consult others on important decisions.

Georgieva and World Bank President David Malpass
Georgieva and World Bank President, David Malpass

Not long after her appointment as CEO, Georgieva set her sights on the World Bank’s bureaucracy. She cut the frequency of regular meetings by half, significantly reduced the length of project documents and shortened the comment process. “What is happening in the world is that change is more profound and it comes faster,” she told Devex in 2017. “We need institutions to be agile and adaptable to change.” In her role, she was also tasked with helping the bank move away from traditional lending models and focus instead on enticing private investors, while also fostering a more results-driven culture.

During Georgieva’s tenure as CEO of the World Bank, her skills as a negotiator shone through. She successfully secured a $13bn capital increase with the Trump administration that put the World Bank’s financial capacity at a record high.

For a four-month period in 2019, she also served as interim president of the bank, during which time she oversaw the lender’s day-to-day operations. In this position, Georgieva once again proved herself to put the needs of poorer countries first. She defended the World Bank’s use of targeted programmes to reduce poverty against critics who argued that universal benefit programmes were more effective. “We are shifting towards the lower-income countries and also towards the countries that are on the frontline of this fight against extreme poverty,” she told the BBC in 2019. “We target those who need it the most.”

 

Critical conditions
Low and middle-income countries with poor access to financial markets are also those most at risk during the coronavirus crisis. So far, the loans approved by the IMF include $5bn for Ukraine, $491.5m for Uganda and $396m for Jordan. Georgieva has urged wealthier nations to do their part and contribute to the fund’s concessional lending facilities. In April, Japan – the largest contributor to these facilities – made a $100m contribution to the IMF’s Catastrophe Containment and Relief Trust. Georgieva has since called on other members to do the same. “By working together, we can overcome the global challenge facing us and help restore growth and prosperity,” she said.

Georgieva has demonstrated a capacity to stand her ground while managing politically fraught situations

Georgieva has also encouraged countries to place their emergency funds in green investments. She has suggested that governments consider taxing carbon to raise revenue for their recovery and incentivise the private sector to cut emissions. “We are about to deploy enormous, gigantic fiscal stimulus and we can do it in a way that we tackle both crises at the same time,” she said. “If our world is to come out of this crisis more resilient, we must do everything in our power to make it a green recovery.”

Despite her efforts, Georgieva has found herself having to defend her strategy to protect the world’s poorest economies in the aftermath of COVID-19. Some think the IMF’s attempts to help these countries don’t go far enough. In May, more than 300 lawmakers from around the world urged the IMF to cancel poor countries’ debt, rather than simply suspending it, to free funds up to fight the virus.

These lawmakers also encouraged the IMF to create trillions of dollars of new special drawing rights (SDR), the currency of the IMF. An SDR allocation can be compared to a central bank printing new money. So far, the proposal has been opposed by the US, which voiced concerns that the funds created through an SDR allocation would mainly benefit countries like China, and not the low-income countries they were intended for. This is because new reserves are allocated according to members’ shares in the IMF. Although the institution’s lending capacity has quadrupled since 2008, its power can still be easily limited by the US, its largest shareholder. Georgieva must win US support if she is to support the most vulnerable economies with an SDR allocation.

The coronavirus crisis puts the IMF in a uniquely difficult position. In a crisis, the IMF is an important safety net for all struggling economies – but the current crisis is unlike others. Ordinarily, when the IMF lends to a country, it insists the nation tightens its spending to ensure the loan isn’t wasted and the IMF can be repaid. But now, Georgieva is urging countries to spend whatever is necessary. While such measures are essential to limiting the virus’ impact, lending with no strings attached could erode the quality of the IMF’s loan portfolio. David Lubin, Head of Emerging Markets Economics at Citigroup, wrote in the Financial Times: “The IMF and its shareholders face a huge problem. It either lends more money on easy terms without the ‘collateral’ of conditionality, at the expense of undermining its own balance sheet; or it remains, in systemic terms, on the sidelines of this crisis.”

The sheer scale of the economic fallout of coronavirus will push the IMF’s ability to lend to the limit. While ensuring the lender can come to the aid of struggling nations, Georgieva also needs to keep one eye on the post-pandemic future. If all goes to plan, wealthier nations will come to the rescue of poorer ones, and emergency loans could help fuel a global green recovery. This is certainly a tall order – however, Georgieva’s track record shows she is more than capable of meeting that challenge head-on.

 

 

Curriculum Vitae

Born: 1953 | Education: The University of National and World Economy

1993
Kristalina Georgieva began her 17-year-long first stint at the World Bank when she was recruited as an environmental economist. She climbed her way up to director of the environment department in 2000.

2008
In 2008, Georgieva was appointed as vice president and corporate secretary of the World Bank. She played a critical role in the bank’s governance reforms in the wake of the 2008 international financial crisis.

2010
Georgieva joined the European Commission, where she managed one of the world’s largest humanitarian aid budgets and led the creation of the EU’s Civil Protection Mechanism, strengthening cooperation between member states.

2014
Incoming European Commission President Jean-Claude Juncker appointed Georgieva as vice president for budget and human resources, making her the most senior technocrat in the commission and placing her in charge of 33,000 staff.

2017
The World Bank announced Georgieva as its first CEO. She played a key role in broad reforms, which involved securing a $13bn paid-in capital increase – the largest funding increase in the bank’s history.

2019
In September 2019, having been the sole nominee for the role, Georgieva was named managing director of the IMF, succeeding Christine Lagarde. She is the first person from an emerging economy to take up the position.

The ascent of behavioural economics

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The roots of behavioural economics go back to the 1950s, when economist and cognitive psychologist Herbert Simon began to look at ways to merge those two fields. Mainstream neoclassical theory had long been based on the idea that humans behave like highly rational automata, bent only on optimising their own utility. However, as Simon noted in 1977, although the “classical theory of omniscient rationality is strikingly simple and beautiful”, the reality was that people had neither the energy nor the resources to optimise their choices. Instead, people aimed to make reasonable decisions by limiting their choices to a small set of alternatives, and by “satisficing” – i.e. choosing an option that is good enough as opposed to optimal.

Simons’ ideas were out of step with trends at the time and, as he described, “there was a vigorous reaction that sought to defend classical theory from behaviouralism on methodological grounds” because it didn’t fit with the increased mathematisation of economics.

That problem was partly addressed by the psychologists Daniel Kahneman and Amos Tversky. Their 1974 paper Judgement Under Uncertainty: Heuristics and Biases provided examples of psychological experiments where classical utility theory broke down. Their 1979 follow-up, Prospect Theory: An Analysis of Decision Under Risk, went beyond this by providing a mathematical model of decision-making that accounted for biases such as loss aversion or uncertainty avoidance.

However, it was the financial crisis of 2008 that brought behavioural economics into the mainstream. One reason was that, at least for non-economists, the financial crisis didn’t gel with the idea that humans always behave as rational utility-optimisers. Behavioural approaches provided a welcome alternative. Another reason was that economics was suffering from a crisis of credibility, which made such alternatives especially welcome.

Finally, behavioural approaches seemed to promise politicians a solution to some of their most vexing problems, in the form of behavioural nudges, as championed by economist Richard Thaler and law professor Cass Sunstein.

 

The architects of choice
Thaler first came across Kahneman and Tversky’s work in 1976. “The paper took me 30 minutes to read from start to finish, but my life had changed forever,” he said. It seemed that Kahneman and Tversky had found a way to put the thrill back into economics.

Thaler’s big idea was that behavioural approaches could be used not just to understand human behaviour, but also to control it by providing behavioural ‘nudges’. He and Sunstein defined a “choice architecture” as the way choices are presented. A nudge was defined as “any aspect of the choice architecture that alters people’s behaviour in a predictable way without forbidding any options or significantly changing their economic incentives”.

Behavioural approaches could be used not just to understand human behaviour, but also to control it by providing behavioural nudges

This theory was enormously attractive to governments, which were trying to bring their economies out of the crisis. Sunstein served in the Office of Information and Regulatory Affairs during Barack Obama’s presidency, while in 2010, then UK Prime Minister David Cameron set up the Behavioural Insights Team, also known as the Nudge Unit, in an effort to incorporate its insights into government policy.

The Nudge Unit has gone on to play an important role in issues from Brexit to the coronavirus crisis. Cameron’s confidence in calling the Brexit referendum was in part based on the assumption that the populace would choose to remain in the EU due to factors like loss aversion and the status quo bias. Thaler explained at the time: “I am not a prognosticator, but I would bet on them staying. And I think that there is a tendency, when push comes to shove, to stick with the status quo.”

Behavioural economists, including psychologist David Halpern, who heads the Nudge Unit, also took a lead advisory role in addressing the coronavirus. As Bloomberg put it in March: “A little-known team of advisors specialising in behavioural psychology is helping to steer the prime minister’s response to the health crisis, shunning headline measures like travel restrictions and quarantines to focus on a more banal task: finding ways to persuade people to wash their hands.”

 

More than a nudge
As behavioural economics has become more influential, it has also come under increasing criticism. Some say it reduces human behaviour to simplistic equations and that supposedly irrational biases such as risk aversion actually make sense when dealing with something like infectious disease (it turns out that viruses don’t respond well to nudging).

Another criticism is that, as marketing professor Philip Kotler claims, the field boils down to “another word for marketing”. It is true that many of its key concepts can be found in marketing manuals from the last century. For example, in his 1923 book Crystallising Public Opinion, the public relations expert Edward Bernays said that “the group and herd are the basic mechanisms of public change”, and argued that psychology could be used to manipulate the masses.

The biggest problem, though, is that it is increasingly obvious that the global economy is faced with major structural challenges such as inequality, financial instability, climate change and the risk of future pandemics, which require more than a nudge to address them.

So, does behavioural economics have a future, or will it go the way of countless other economic fads? Perhaps I am biased (as cognitive scientists point out, we all are), but my bet is that it is a transitional stage between mainstream economics and something more radical. After all, economics needs more than a nudge as well.

The rise of the titans

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Before the financial crisis, passive investing was a little-known niche. Today, though, passive funds, such as index funds and exchange-traded funds, dominate global markets. Fund managers who entered the market early – namely, BlackRock and the Vanguard Group – now have over $6trn in global assets under management apiece. Contrary to analysts’ predictions that a period of extreme market volatility could chip away at their dominance, the COVID-19 pandemic may entrench it.

 

Success at any cost
Unlike active funds, passive funds are designed to match the components of a financial market index – such as the S&P 500 – in the belief that the market will outperform any individual stock in the long term. In the words of John Bogle, the late founder of the Vanguard Group: “Owning the stock market over the long term is a winner’s game, but attempting to beat the market is a loser’s game.”

These funds have been growing in popularity since they first emerged in the 1970s, but it was following the 2008 financial crisis that their adoption took off. “Some of this is because of how poorly active management performed during the financial crisis and because people realised how much they were paying,” Todd Rosenbluth, Director of Mutual and Exchange Traded Fund Research at CFRA Research, told World Finance. “And then part of it is this snowball effect. So once money starts to go in, the scale increases, the fees come down even lower and that drives further and further adoption.”

Passive funds’ dominant position in the market is all down to cost. Without the need to employ the services of research analysts and others who try to select winning stocks, passive funds can afford to keep their fees much lower than active funds, giving them greater appeal among investors.

Ever since Vanguard first set the precedent on cheap products, passive funds have been aggressively slashing their fees in a price war that some analysts have dubbed ‘feemageddon’. In 2018, Fidelity Investments became the first financial services company to offer a zero-fee index fund.

“For newer entrants, if you’re going to enter the passive fund market relatively late, then you have to do so [by] either being different than everybody else or cheaper than everybody else,” Rosenbluth said. Meanwhile, active managers have been forced to join forces to remain competitive. In February, Franklin Resources announced it was buying rival Legg Mason for $4.5bn.

 

A big problem
According to Reuters, index funds now control half of the US stock mutual fund market. Michael Burry, one of the fund managers highlighted in the film The Big Short, caused a stir in 2019 when he claimed that index funds were the next bubble, comparing them to the collateralised debt obligations that sparked the 2008 financial crisis.

Passive funds have been aggressively slashing their fees in a price war that some analysts have dubbed ‘feemageddon’

But Rosenbluth disagrees: “The people who are arguing that are people who stand to get hurt by the growth of passive management, and those are active managers. At the moment, there’s still a very small amount of securities that are held by passive investments… It’s not accurate that passive products are causing a bubble in the market. Stocks go up or down because people buy stocks. A very small percentage of people buying stocks are still using passive products to get their exposure.”

Even Vanguard’s Bogle expressed concerns that a handful of asset managers had become too big for their own good. Today, Vanguard is the biggest shareholder in almost every major listed US company. Regulators have raised concerns that its dominance could undermine corporate governance in the long term.

 

On the up
In theory, active managers who try to beat the market by picking winning stocks should thrive in times of volatility. That’s why, when the COVID-19 pandemic caused stocks to hit record lows, many analysts expected investors to pull out of passive funds. That was not the case, however: according to an analysis from US-based research group Flowspring, the migration of investors to these groups accelerated in the first three months of the year. “It turned out that not everybody rushed for the exits,” Rosenbluth told World Finance. “In fact, people ran in towards passive products. So I think it debunked the myth that these products were not as liquid as they were.”

Passive funds have reshaped global asset management with their provision of low-cost products. For the time being, a swing back to active funds looks unlikely. “We’ll see how active management performs,” Rosenbluth said. “If we end the year with losses, those typically cause people to then determine they’re not happy paying the premium for active management. That’s what we saw in the financial crisis.”

Blurred vision

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In 2019, Saudi Arabia’s Crown Prince, Mohammed bin Salman (MBS), seemed close to achieving his plans for major economic transformation. Having raised nearly $26bn for his reform programme through the initial public offering of state oil company Saudi Aramco, the crown prince looked on track to reduce the kingdom’s reliance on oil revenues and carve out a place for the Gulf nation as a global entertainment and tourism hub. But the twin blows of the COVID-19 crisis and an oil price collapse are now threatening to pour cold water on his ambitions.

In the first three months of the year, the kingdom entered into a $9bn budget deficit as state spending outstripped income. To shore up reserves, the Saudi Government tripled its value-added tax and suspended the cost-of-living allowance for state employees. In total, government spending cuts amounted to SAR 100bn ($26.64bn) – roughly 10 percent of total expenditure from the original 2020 national budget. Finance Minister Mohammed Al-Jadaan insists the austerity measures, which many Saudis have railed against on social
media, are “painful but necessary”.

As part of the cuts, the government has also slashed SAR 30bn ($8bn) from Vision 2030, the strategic framework created by MBS to diversify Saudi Arabia’s economy. Al-Jadaan told Saudi television network Al Arabiya that the government was planning to delay some of the projects, which include a luxury resort on the Red Sea and a $500bn futuristic city called Neom, which would be complete with a giant artificial moon. It’s the most significant crisis Vision 2030 has witnessed since its inception in 2016, and it could jeopardise Saudi Arabia’s chances of achieving economic diversification.

 

A double blow
Despite its recent diversification push, the oil and gas sector still accounts for roughly 50 percent of Saudi Arabia’s GDP. By far the worst impact of COVID-19 on the kingdom so far has been the loss of this income, as crude oil prices were pushed to their lowest level in four years.

“The pandemic creates some short-term damage to the tourism and entertainment sectors, which have emerged as a key focus in the Saudi diversification agenda,” Dr Steffen Hertog, an associate professor in comparative politics in the Department of Government at the London School of Economics and Political Science, told World Finance. “This will pass. What is more problematic is the fiscal impact of the [COVID-19] crisis, which has led to a collapse of global oil prices.”

To fund its budget, Saudi Arabia needs oil prices to stand at around $85 per barrel, according to the Brookings Institution. In the wake of the coronavirus outbreak, however, the price per barrel plunged to $25. The Institute of International Finance has predicted that Saudi Arabia – along with the other five nations in the Gulf Cooperation Council – will suffer its worst recession ever in 2020 as a result.
Even before the crisis, oil prices had been dwindling, forcing the kingdom to eat into its reserves. Now, the Saudi Government is depleting these reserves at an even faster pace – at the expense of Vision 2030. “While prices might recover in 2021, the large deficit in 2020 means [a] rapid drawdown of fiscal reserves, [decreasing] the room of manoeuvre for large-scale project spending, including for [Vision-2030-related] projects,” Hertog said. “This impact will be longer-lasting and require [a] more austere fiscal policy for years to come, which will also mean lower growth.”

 

Putting the brakes on
The COVID-19 pandemic has not just limited Saudi Arabia’s capacity to spend on projects – it has also reduced consumer demand for them. Much of Vision 2030 revolves around the idea of building Saudi Arabia into a global transportation and tourism hub, connecting Europe, Africa and Asia. But the spread of SARS-CoV-2 has blighted the transport industry: air travel, for example, is not expected to return to 2019 levels until at least 2023, according to the International Air Transport Association.

The COVID-19 pandemic has not just limited Saudi Arabia’s capacity to spend on projects – it has also reduced consumer demand for them

Then there’s the impact the pandemic could have on businesses. Over time, austerity measures and reduced consumer spending could take a toll on the private sector. According to the IMF, non-oil-sector growth is projected to fall to 1.4 percent this year, down from three percent in 2019. Public support could also suffer: in a country with no elections, where the social contract between state and citizens usually depends on a high quality of living, the public’s ability to tolerate austere policies is critical. If this tolerance wanes, it could seriously dampen MBS’ popularity.

A major economic slowdown and civil unrest are both factors that could impact investors’ willingness to inject capital into Saudi Arabia. Although budget cuts and delays might seem like short-term obstacles, the longer the country is economically vulnerable for, the further into the distance Vision 2030 will shrink.

Caught in a debt trap

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China has something of a mixed reputation when it comes to its overseas investment practices. Although its money is usually welcomed by developing countries where funds are scarce, Beijing’s accompanying demands can sometimes cause friction. The case of Sri Lanka’s Hambantota Port is a lesson to all countries that remain wary of getting caught in China’s debt trap. After the Sri Lankan Government could no longer keep up with payments for the port – which was heavily funded by Chinese investment – it was left with no choice but to sign it away to Beijing on a 99-year lease, along with 15,000 acres of surrounding land.

This reputation will now be put to the test as many recipient countries struggle to make repayments while managing the economic turmoil wreaked by COVID-19. Already, reports are circulating that many of the countries involved in China’s Belt and Road Initiative (BRI) need debt relief. But whether Beijing acquiesces to such a request remains to be seen.

 

Tightening the belt
Launched in 2013 as Chinese President Xi Jinping’s flagship policy, the BRI aims to facilitate infrastructure development around the world through investments totalling over $1trn. Notable successes include bringing high-speed railways to Indonesia, strengthening Greece’s maritime infrastructure and boosting

Djibouti’s position as an international trade and logistics hub. Information collected by the Centre for Economic Policy Research’s policy portal, VoxEU, found that BRI transport infrastructure projects increased GDP for participant economies by up to 3.35 percent.

Many of China’s BRI loans have gone to developing nations. According to the Washington, DC-based consultancy firm RWR Advisory Group, 15 of the top 20 recipients of BRI loans between 2013 and 2020 had an OECD risk classification of five or above; four were given the highest possible risk factor of seven. The COVID-19 pandemic could quickly make the financial situation in these countries unsustainable.

“The debt situation of BRI borrowing countries varies,” Scott Morris, a senior fellow at the Centre for Global Development, told World
Finance. “Many entered the current crisis with manageable debt loads, but some were already experiencing rising debt risks. Low-income countries, which have had limited access to commercial credit and have relied significantly on borrowing from China, are particularly vulnerable to debt distress. This is particularly [the case] for commodity exporters.”

According to The New York Times, Pakistan, Sri Lanka and several African countries are among those to have asked Beijing for a delay, restructuring or outright cancellation of debt since the COVID-19 pandemic

began. Some debt relief is likely to be granted, but what form it takes remains to be seen. For many of the countries that are currently struggling economically, rescheduling is unlikely to be enough and debt reductions will be necessary. It’s not clear whether China is willing to go this far, or whether the government will do so in coordination with an international creditor organisation like the IMF.

 

A bump in the road
The COVID-19 pandemic has spread rapidly and caused nations around the world to take unprecedented action, much of which has hamstrung their respective economies. In the developed world, there is a growing acceptance that this economic damage is likely to hit the poorest nations the hardest. In April, G20 nations agreed to freeze bilateral loan repayments for low-income countries until the end of the year, calling on private creditors to follow suit. Despite agreeing to the deal, China has muddied the waters somewhat by declaring that it will negotiate with borrowers on a bespoke, bilateral basis.

The COVID-19 pandemic has caused nations around the world to take unprecedented action, much of which has hamstrung their respective economies

“It appears that China intends to pursue negotiations through bilateral channels, which undercuts the ability of other creditors to pursue a coordinated approach,” Morris said. “If a large number of borrowing countries are seeking relief simultaneously, it may tax the ability of the Chinese Government to sustain this bilateral approach. China has no experience as a leading creditor in a systemic debt crisis.”
Moving forward, an important question for the BRI and other forms of Chinese lending is the degree to which terms will be adjusted to reflect the circumstances of borrowing countries. Lending concessionality is a key principle of multilateral lenders like the World Bank, but China has historically favoured practices more aligned with those of commercial lenders.

With the world watching, China will have to tread carefully in terms of how it reacts to the growing number of requests for debt relief. The BRI was envisaged as much as a PR exercise for Beijing as it was an infrastructural support programme for the world’s poorest countries, but problems have been mounting for some time. In 2018, a study conducted by the Centre for Global Development was already predicting that the BRI could bankrupt eight countries. That prediction may now need to be revised upwards.

Learning the hard way

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When the World Health Organisation declared the COVID-19 emergency a pandemic on March 11, 2020, all major industries – financial services being no exception – had to face one of their most serious challenges in decades. This human tragedy, which sadly spared no country, will lead to one of the worst economic downturns since the Great Depression. In fact, according to the IMF, the cumulative loss to global GDP caused by the pandemic could reach $9trn through 2020 and 2021.

At the time of writing, the crisis had started to slow down and the Principality of Monaco, where Compagnie Monégasque de Banque (CMB) is headquartered, had ended its lockdown. At this stage, the crisis is by no means over and it is too early to claim victory. Nevertheless, key lessons can already be drawn from this exceptional situation, and the measures put in place by CMB will help the bank move forward in the most efficient way possible.

 

Shifting priorities
In a crisis, being clear on what matters the most acts as a beacon for decision-making. When navigating uncharted waters, prioritising certain tasks and using them as a guiding light allows one to be more efficient and to ensure consistency in the actions they take. At CMB, the priority was clear from the beginning of the crisis: to protect our customers, employees and partners, while maintaining a quality of service that meets our clients’ expectations.

To that end, immediate efforts were undertaken to ensure the safety of our on-site employees, with several important measures quickly put in place. For example, we reinforced cleaning teams and deployed a dedicated cleaning agent to each site. We also disinfected offices (including air-conditioning systems) with professional sprays, and distributed wipes and hydroalcoholic gels to employees, with all client-facing staff receiving masks.

Furthermore, we started temperature testing our employees every morning and implemented a systematic work from home policy for any employee showing signs of flu and/or a temperature. Workstations are now spread out further within departments and we have covered the payment of parking, petrol and toll charges for employees who usually come to work via bus or train to help them avoid public transport.

Banking is one of the industries needed to keep economies afloat. As one of Monaco’s leading private banks, it was necessary to ensure the continuity of our operations. As with most banks, the first basic steps were reducing branch hours while ensuring ATMs remained open and had enough cash to dispense. But it also meant reviewing existing processes – making necessary updates to provide organisational resilience – and guaranteeing technological options were in place to connect the employees working at home without compromising data security. At the same time, campaigns to raise employee awareness of phishing and fraudulent attempts to exploit the health emergency were undertaken. More than ever, banks began to view cybersecurity not only as an IT issue, but also as a general business threat.

In the next few years, we believe digital disruption will intensify. In this environment, industry players with a highly traditional banking culture may struggle to adapt and establish a digital mindset. Developing and retaining the right talent to not only face these major risks but also turn them into opportunities will be absolutely necessary. The crisis has acted as an accelerator of this ongoing trend.

 

Going above and beyond
The COVID-19 pandemic has created strong tensions across financial markets, with worsening conditions heightening the risk of a credit crunch and increasing spreads and interest rates. The ensuing high volatility has highlighted the importance of having a banker who is genuinely attentive to client needs and competent enough to provide tailor-made advice. The core role of private bankers – to reassure and advise – appeared all the more crucial amid the uncertainty.

This COVID-19 crisis has led all businesses to assess their current capabilities and, if necessary, recalibrate for the future

Trading and hedging strategies also needed to be adapted quickly and efficiently, as a decline in prices across many asset classes increased market and counterparty credit risk. At CMB, we decided to offer tactical investments, especially on blue-chip companies that represented attractive medium-to-long-term investments.

It is important to note that in any crisis, clear communication becomes both more important and more challenging. There is a strong appetite for information – both internally and externally – and it is of crucial importance to maintain this connection between bankers and clients by using secured video conferencing tools that offer convenience while maintaining the value of face-to-face interactions.

Furthermore, the crisis highlighted the importance of being able to offer the most seamless digital experience to clients, especially through mobile and e-banking solutions. For instance, CMB Mobile, one of the most secure private banking apps on the market, meets the needs of an increasingly connected customer base. Thanks to this mobile application, the bank’s customers were able to consult their accounts in a consolidated manner, make transfers and even communicate with their private banker via dedicated messaging, all in a safe environment. The increased use of digital devices during containment also called for a reinforcement of client support to aid the use of remote banking services.

 

Looking to the future
Sustaining employee engagement and wellbeing is unquestionably important all year round. Employees who feel at ease are more productive and efficient, but in an unprecedented context such as this one, staff members have had to cope with a new level of stress, adapt to different ways of working and be even more agile than usual.

As far as CMB is concerned, some measures have been particularly effective in ensuring the wellbeing of our teams, both onsite and at home. First of all, we gathered feedback on employee concerns and queries via our human resources department. Second, we created a psychological support unit offering remote sessions with complete anonymity. For employees working onsite, we provided breakfast and lunch to limit the need for visiting public places, which we identified as a potential risk and source of stress. Most importantly, we worked to create an environment of dialogue between management and employees, giving regular updates via email and conference call, outlining the measures being put in place on a day-to-day basis and, above all, explaining the reasons behind each decision.

Another lesson the crisis has taught us is that when the private sector pivots to serve the greater good, its reach and power is immense. From fashion firms producing face masks to manufacturers and tech start-ups reinventing themselves to support local communities, many companies highlighted the positive role that can be played by businesses. As a key facet of the Monégasque economic fabric, CMB has an undeniable social responsibility locally. We decided, therefore, to donate 11,000 masks and launch a major fundraising campaign in favour of the Princess Grace Hospital. The sum of €100,000 ($112,095) was granted to the hospital and a total of €470,955 ($527,915) was raised. CMB believes that, in the post-pandemic world, the question of what good business looks like will be even more important.

This crisis of unprecedented scale, duration and geographic extent has led all businesses to assess their current capabilities and, if necessary, recalibrate for the future. Among other priorities, private banks should look to invest more in technology and fintech firms to deliver efficiencies and superior client experience, as well as build strong capital ratios that can face any unforeseen liquidity crunch. Most importantly, private banks should ask themselves how they can continue to embrace agility to enhance the customer experience.

It is now time for all industries to think about the changes in mentality and work habits that are likely to follow containment – notably, remote working, media-sharing platforms, video conferencing and cloud solutions. The sustained experience of social distancing and the fear of contagion has been a human experience that will change us all on an individual and collective level. Client behaviours will undoubtedly change coming out of the crisis.

There was a world before COVID-19 and there will be a new world after. Our social interactions will be redefined, but there will also be a new order in the way we work and the values we promote within organisations. The meaning of work will come under greater scrutiny and companies wishing to attract top talent will have to be very clear about the purpose of their business.

As we are given a unique opportunity to reflect and make business more culturally connected and responsive to society’s needs, we will need to learn to navigate novel ways of working and connecting with staff, clients and wider stakeholders. The door to bold new thinking, working practices and means to address client needs has been opened, and it is time for businesses to reinvent themselves for the better. We are at a critical juncture, and I am confident that the winners will be the ones who can embrace these changes.

Australia confronts the difficulties of curbing economic ties with China

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In a private conversation with German Chancellor Angela Merkel in late 2014, Australia’s then-Prime Minister Tony Abbott confided that Australia’s policies towards China were driven by two things: “fear and greed”. It was an awkward comment to find its way into the press – not least because, in official statements and documents, Australian officials usually waxed lyrical about the importance of maintaining Sino-Australian relations. But Abbott’s admittance was revealing of the bipolarity at the heart of Australia’s relationship with China.

Australia’s economy is highly reliant on the China. “Of all the major liberal democracies, Australia has the largest economic links with China in terms of investment, and flow of goods,” said Kerry Brown, Professor of Chinese Studies and Director of the Lau China Institute. This close economic relationship has become more problematic as China has moved to erode the freedoms of citizens in Hong Kong and repress the Uighur population, prompting liberal democracies to weigh their trading relationships with the country against their own values.

But it’s not just China’s human rights record that had been cause for concern. China’s made it increasingly clear that it’s willing to use economic coercion to penalise Australia during political spats. When Canberra called for an inquest into the origins of the coronavirus in April, Beijing responded by slapping tariffs on beef and barley exporters and warning students and tourists against travelling to the “racist” country. Ever since, fears have grown among Australian policymakers, businesses and economists that the country’s economic dependence on China could be a major liability.

 

Close ties
Australia owes its economic prosperity partly to China’s meteoric rise. As the Asian country rapidly industrialised from the 1970s onwards, Australia tangentially benefitted through the supply of raw materials, iron ore and, more recently, agricultural produce. “[These economic ties] have ensured that even during the economic crisis of 2008-9, Australia was able to maintain good growth, and has not had a recession since 1991,” said Brown.

In more recent years, China has also become a major client for Australia’s agricultural produce, tourism and education. China is the largest source of tourists and also foreign students to Australia, injecting billions into the economy every year.

Although this relationship had been mutually beneficial, it’s worked more in Australia’s favour. China’s own reliance is not quite so strong. “The relationship is asymmetric because of the size of the two economies,” said Hans Hendrischke, professor of Chinese business and management at the University of Sydney Business School. “In summary, Australia’s dependence on China is across the board, including goods and services, whereas China’s dependence on Australia relates to steel for infrastructure investment and to goods and services in demand by China’s middle-class consumers.”

That economic dependence is only increasing. Despite rising tensions, Australia continues to record a trade surplus with China. “In June 2020, half of all Australian goods exports (48.8 percent) went to China,” said Hendrischke. This figure is up from a third in February. Exports of iron ore to China, in particular, are on the increase, according to the Australian Bureau of Statistics, given China’s rising demand for steel to supply new infrastructure projects.

 

Rising tensions
For a long time, Australia and China’s relationship proceeded in a state of relative harmony. “The relationship over the last 20 years in particular has been one of opportunism and expediency on the part of Australia, just enjoying the benefits and never thinking much about the more complex issues,” said Brown. “That has slowly changed over the last few years, and seems to be dramatically changing now.”

Since the start of the pandemic, relations with China have steadily worsened. Australia’s criticism of China’s handling of the coronavirus outbreak angered the communist state. At the same time, when China imposed its national security law on Hong Kong, Australia warned its citizens against travel to Hong Kong and suspended its extradition treaty with the territory. In a secretive process, China sentenced an Australian man to death for drug smuggling. “Government and media attitudes towards China have changed toward animosity if not outright hostility,” said Hendrischke.

There are economic consequences to this rising tension. In May, China placed tariffs on 80 percent of Australian barley and bans on abattoirs that could block 35 percent of Australia’s exports of beef to China.

The damage caused by China’s recent tariffs won’t be immense; these exports represent only a small amount of the total A$153bn that represented Australia’s exports to China in 2019 (an amount equivalent to 7.7 percent of Australia’s GDP). There is only so much harm China can inflict without harming its own interests.

“Looked at from the point of view of the Chinese government not wanting to hurt its own economy,” said Michael Shoebridge, Director of Australian Strategic Policy Institute’s Defence, Strategy and National Security programme, “the most vulnerable sectors are those where there is not a deep structural need for Australian exports and services as part of trying to stimulate China’s economy during the pandemic.  So, iron ore, other natural resources and energy seem the least vulnerable – and the trade with China has been growing over this year as a result. Wine, dairy and other exports that are aimed at China’s wealthy and its rising middle class are more discretionary imports where Beijing may have room to act coercively – even though Chinese consumers value the quality of these Australian products highly.”

Since tourism and education are not exclusive to Australia, these sectors are among those more vulnerable to economic coercion by China. For instance, China’s call for its citizens to avoid the “racist” country is predicted to have a knock-on effect on Australia’s tourism and education revenues.

Shoebridge points out that this was something of an empty threat. “Chinese tourists and students are stopped anyway because of the pandemic,” he said. “So, these ‘future threats’ from Beijing only show the manifest risks to Australian business and universities if they continue to build their business plans on assumptions of a reliable market from China.  Beijing is actively raising the sovereign risks that companies and other institutions need to factor in to doing business with China.”

Even though the pressure applied by China is only slight, it has nonetheless spooked businesses and investors. Morgan Stanley’s analysts said in June that the “continued escalation in trade friction” between the countries was one of the biggest risks to Australian stocks.

Australian businesses with Chinese ties are particularly nervous. According to the Australia-China business chamber AustCham, a survey of 87 Australian businesses in China found that 70 percent of them were concerned about the deteriorating relationship, up from 45 percent two years ago.

 

Burning bridges
While many business leaders believe Australia must patch things up with China for the sake of economic prosperity, large swathes of the public are in support of Australia drastically reducing its reliance on China. A survey by the Lowy Institute found that as many as nine in 10 Australians now believe the Australian government should steer the economy away from its number one trading partner, due to concerns around Australia’s national security.

But this is easier said than done. Australia can only decouple from China if it builds up relations with alternative trading partners. “Australia’s future industrial development will depend on its ability to diversify away from China and more into the region,” said Hendrischke. “There is no limit to how far Australia should spread its market risk.”

Together, trading partners like Indonesia, Japan and South Korea could help the country reduce its reliance on China. Australia is now urgently trying to build ties with these nations. In July, a hard-won free trade agreement with Indonesia came into effect and, in August, Australia signed a digital economy agreement with Singapore intended to make cross-border activities more cost-effective more businesses in the two countries.

India could also prove an increasingly significant strategic partner. Australia has set the goal of sending A$45bn ($31bn) in annual exports to the country by 2035.

However, some doubt that any of these trading partners will have the economic clout needed to replace China. “Decoupling would mean urgently seeking new markets – none of which would be able to fill the space left by China perhaps ever, and probably for decades,” said Brown. “In addition, Australia’s universities have huge numbers of Chinese students. That too would be a massive and painful gap to fill were these student numbers to dramatically fall.”

For this reason, the Australian government is being cautious in the tone it takes against the economic giant. The foreign minister, Marise Payne, said Australia had “no intention of injuring” its important relationship with Beijing.

Of course, China is in a similarly precarious position. Although it may not be as economically reliant on Australia as Australia is on it, China also stands to gain from diversification, but can’t achieve this easily.

“The question of decoupling is the old question of how to reduce over-reliance on one dominant business partner in a new guise,” said Hendrischke. “Spreading risk makes commercial sense under any circumstances. Australia and China are caught in a bind, as Australia is over reliant on Chinese demand across the board in all major export industries, while China is over reliant on Australian iron ore supply for crucial infrastructure. Both countries would prefer a wider spread of their commercial risks and both are unable to achieve this in the short- to medium-term without causing economic damage to their economies.”

 

A changed relationship
Eventually, the recent political headwinds will blow over. New research from Australia’s National University shows that the impact on trade from the recent spat is likely to be minimal. This was based on two decades of monthly trade data, which showed that the fall-out from trade disputes usually lasted three months before normal trade resumed.

However, that doesn’t mean Australia can afford to be complacent about its relationship with China. Even if this trade dispute dies down, ideological clashes are likely to continue.

“As it has done so far, Australia’s government should be open about its decisions the reasoning behind its decisions,” said Shoebridge. “We should continue to be open when we see attempts at coercion from the Chinese state and we should welcome and work with partners who share our interests and support. Australia is not alone in dealing with the way Xi is pushing his government to behave, so we should also look for opportunities to speak up and support others when they are the subject of China’s coercion. Keeping calm and clear is useful here, with all the emotion and stridency left to Beijing.”

“Fear and greed” may have driven Australia’s economic ties with China for several decades. But now the country is entering a new, more cautious stage of its relationship with the Chinese state. Whatever this entails, it’s clear the hay days of the Sino-Australian cooperation are coming to an end.

Cold Turkey: Coronavirus further weakens the lira

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It’s not often that a pastor sparks an economic crisis, but this is exactly what happened in 2018 when Andrew Brunson, a Christian missionary who left the US for Turkey’s Aegean coast, was accused of plotting to overthrow the Turkish Government. To penalise Turkey for his arrest, the US doubled steel and aluminium tariffs, quickly sending the Turkish lira into free fall. In the space of just 24 hours, the currency had lost 20 percent of its value.

As costs for businesses and prices for consumers shot up, Turks took to social media to rail against the US. Many citizens filmed themselves burning dollar bills, one Turkish butcher ‘minced’ his notes, while another man took a hammer to an iPhone. A columnist for the Hürriyet Daily News later pointed out that, to upload the video, the protestor probably used another iPhone, or at least a phone with an operating system made in the US.

Now, Turkey could be heading for its second currency crisis in just two years. The lira weakened 16 percent in the first five months of 2020 as the coronavirus pandemic triggered massive capital outflows from emerging markets. According to the Institute of International Finance, March saw more than $80bn in investment flee from a group of over 20 emerging economies, including Turkey.

Once again, the country is burning through its dollars – only this time, not in protest, but as part of a desperate attempt to keep the lira from depreciating. At the start of the year, the country’s central bank had roughly $40bn in foreign exchange reserves, but this figure plummeted to $25.9bn by mid-April, while state banks have sold at least $32bn worth of hard currency.

Without sufficient foreign reserves, Turkey could struggle to weather the economic slowdown caused by the coronavirus crisis, which has already deprived the country of critical income from exports and summer tourism. The country’s erratic economic policy – pushed by President Recep Tayyip Erdoğan – isn’t helping.

 

Unconventional policy
Erdoğan has had a much greater influence on Turkey’s monetary policy than his predecessors. “When the people fall into difficulties because of monetary policies, who are they going to hold accountable?” he asked in a 2018 interview. “They’ll hold the president accountable. Since they’ll ask the president about it, we have to give off the image of a president who’s influential on monetary policies.”

Except Erdoğan seems to have a deep misunderstanding of some of the monetary tools he’s deploying. He has repeatedly challenged the purpose of high interest rates, calling them “a tool of exploitation”. Even as Turkey’s inflation rose to 18 percent in August 2018, Erdoğan refused to raise interest rates, insisting it would further hike inflation.

Views like this have led economists to label the president’s economic beliefs “unorthodox”. Orkun Saka, an assistant professor of finance at the University of Sussex, told World Finance: “The mainstream economic theory suggests that a country has to increase interest rates if it wants to boost the attractiveness of its currency and to contain the inflationary expectations… The president seems to believe the opposite – in the sense that he suggests lowering rates will also lower inflation. So far in Turkey, we do not see much evidence in favour of the latter argument.”

The seemingly self-sabotaging decision to keep interests rates low has rattled investors’ confidence. On May 21, Erdoğan cut interest rates for the ninth time in a row in a bid to spur cheap credit. But analysts warn that this could simply hike inflation and deter investors from holding lira or lira-denominated assets.
There is another mainstream economic theory – called the ‘trilemma’ – that Erdoğan has defied. “The trilemma says that a country can only maintain two of the following three policy objectives: a stable currency, an independent monetary policy (to choose whatever interest rate the government wants) and free capital flows,” Saka said. “Turkey had maintained a stable currency and free capital flows for a long duration under Erdoğan’s rule. However, with the increasingly more visible preference for choosing his own interest rates in the last few years, the country is now [starting] to pay the price by having to impose capital controls.”

 

Overstepping the mark
As well as keeping interest rates low in defiance of economic logic, this year, Erdoğan has also taken increasingly creative steps to prop up the country’s battered currency. “As the authorities realise reserves cannot contain a depreciation trend forever, they have started strengthening their regulatory framework and putting obstacles on easily exchanging the lira across borders,” Saka said. For example, Turkish authorities introduced measures to make it more difficult for foreign investors to bet that the currency would fall. “Some of the interventions also came a bit out of the blue,” Saka said. “Such as the one where regulatory agencies initiated an investigation for JPMorgan in 2019 due to its advice at the time to short the Turkish lira.”

These attempts to prop up the lira backfired spectacularly. Restrictions on short selling and speculating about the currency spooked investors and, as a result, on May 7, the currency hit an all-time low of TRY 7.2 per US dollar (see Fig 1).

Value of the Turkish Lira

Keeping the lira below seven per dollar is often described as psychologically important to Turkey. Although the significance of the number is arbitrary, the anxiety surrounding any dip in the currency is a testament to Turkey’s high levels of foreign debt. “As the foreign currency price increases, the amount of debt rises and erodes the balance sheets of the debtor companies,” said Turkish economist and writer Mustafa Sönmez. “It only serves exporters and tourism professionals – the foreign currency winners. But in Turkey, foreign exchange expenditure is heavier, so this spells trouble for the country.”

On the same day that the lira’s value plummeted dramatically, Turkish authorities introduced a transaction ban on BNP Paribas, Citigroup and UBS, further undermining investor confidence. However, the ban was only in place for four days. Saka believes there was a somewhat rational explanation for the move: “It declared a ban on the grounds that these banks failed to satisfy Turkish lira liabilities vis-a-vis local ones. This recent act seems to be a rules-based decision, though, in line with the recently updated regulations… It was a good sign that the sanctions were lifted on these banks as soon as they complied with the local rules.”

 

National pride
Although interventionist measures can spook investors, Saka points out that such manoeuvres are sometimes necessary in the short term. “Whether this is good or bad for the country depends on what type of investors would be discouraged by these interventions and how long the restrictions stay in place,” he explained. “Currency markets are inherently volatile and, especially in times of heightened global risk aversion, can create self-fulfilling trends where the speculation itself may become the sole reason why investors might be shorting a currency.”

However, while interventionist measures like this are common in emerging markets, Turkey has nevertheless been overzealous in deploying them. “It is not unusual for emerging markets to have an interventionary stance in the aftermath of a currency crisis,” Saka said. “We interpret this as something that countries do to stabilise their currencies. However, we also find such interventions to be temporary and to be left behind after a few years. If they become permanent features of the Turkish financial markets, then there is a risk that the country may lose investors.”

Without sufficient foreign reserves, Turkey could struggle to weather the economic slowdown caused by the coronavirus crisis

Since the stability of the lira is treated in Turkey as a key sign of the economy’s health, it is highly politicised. “Let us not use dollars,” Erdoğan told his party’s parliamentary group in November 2019. “Let’s turn to Turkish lira. Let us show our nationalism.” When the value of the lira plunged in May 2020, Erdog˘an blamed this on foreign powers intending to “destroy” the economy.

Scapegoating other countries in this way is a repeated tactic of Erdoğan’s. When Turks destroyed US dollars during the 2018 currency crisis, it was in part because Erdoğan’s strong anti-US sentiment had inspired them to do so. But while it’s true that Brunson’s arrest and President Donald Trump’s subsequent tariff increase did accelerate the lira’s fall in value, the country was already steeped in economic problems.

 

Need a dollar
Under Erdoğan, borrowing and foreign debt have soared. This is largely because of the president’s major infrastructure projects, which include a new airport in Istanbul, costing $11bn to build, and the Çamlıca Mosque, now the biggest mosque in the country.

This construction boom was followed by a painful hangover. “The growth rate of 2019 was close to zero and was accompanied by 14 percent unemployment, double-digit inflation and unpayable external debt problems,” Sönmez told World Finance. “The pandemic has exacerbated all these problems. Now the estimated unemployment is 30 percent, foreign capital outflow has occurred, [and] the dollar price fluctuates in the amount of seven lira. The IMF estimates the shrinkage rate by five percent, but it could exceed 10 percent.” Turkey is now juggling a toxic combination: low reserves as well as debt costs of roughly $170bn. Because of this heavy reliance on foreign capital, Turkey is considered extremely vulnerable to economic slowdown.

To bolster its depleted reserves, Turkey has been attempting to build currency swap lines between its central bank and foreign central banks. The US Federal Reserve, despite agreeing on swap lines with 14 countries, seems reluctant to lend a helping hand. Qatar, however, has offered to boost Turkey’s foreign exchange reserves by as much as $10bn – a lifeline that could help its balance of payments. The lira saw a slight rise in value after the swap line was announced.
However, it’s dollar swap lines that Turkey really needs. “If the Erdoğan government cannot find a source for the short-term debt of $170bn – which should be paid in the next 12 months – it will not be able to keep the foreign exchange price or increase,” Sönmez said. “This will affect all balances negatively.” He points out that a bailout could be on the horizon, although Erdoğan has repeatedly ruled this out as a possibility, adding: “The only option for finding outsourcing is the IMF way, which will [cost] him a heavy political price. His hope is that the effect of the pandemic in the world will pass and that money will be re-entered from abroad. But this is no longer easy.”

Turkey is highly dependent on foreign financing. But, for the last several years, Erdoğan’s heavy management of the nation’s currency has deterred foreign investors from committing the capital that the country urgently needs to balance its payments. Now, with debt high and reserves low, Erdoğan would be wise to seek the help of the IMF. But if his track record is anything to go by, Turkey’s strongman president would rather maintain his stranglehold on the economy, even if it crashes as a result.

Indian central bank keeps interest rate unchanged as inflation rises

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India’s central bank decided to keep interest rates on hold in its policy review meeting on 6 August, as a recent increase in retail prices caused inflation to rise past the 6 percent mark. The six-member monetary policy committee (MPC), which Reserve Bank of India (RBI) Governor Shaktikanta Das leads, kept the repo rate unchanged at 4 percent and the reverse repo rate unchanged at 3.35 percent.

“Given the uncertainty surrounding the inflation outlook and extremely weak state of the economy in the midst of an unprecedented shock from the ongoing pandemic, the MPC decided to keep the policy rate on hold,” Governor Shaktikanta Das said.

The repo rate is the rate at which the RBI lends to banks, whereas the reverse repo rate is the rate at which is borrows from them. Since February, the RBI had reduced the repo rate by a total of 115 basis points.

The committee said it would maintain an accommodative policy stance for “as long as necessary to revive growth”. Although economic activity in India has started to recover from the March to May period, growth for the year is expected to decline as a result of lockdown measures. The World Bank predicts that India’s economy will contract 3.2 percent in the current fiscal year. This is a significant downgrade from its April projection of 1.5 percent to 2.8 percent.

BMO Bank of Montreal reaffirms its approach during the pandemic

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At the start of 2020, the Canadian economy looked set for a solid 12 months. Growth was predicted to pick up slightly from 1.5 percent in 2019 to 1.8 percent (see Fig 1), with the real estate market, in particular, promising investors decent returns. But then the COVID-19 pandemic began to sweep across the globe, undermining economic expectations the world over.

In Canada, despite governmental support packages, the uncertainty caused by the pandemic has led to financial challenges for individuals and businesses. Livelihoods have been lost and many industries will never be the same again. Even when discounting company closures and bankruptcies, a three-month lockdown will cost the Canadian economy an estimated CAD 90bn ($66bn).

In light of the unprecedented situation facing the country (and the world), many financial institutions in Canada have put additional measures in place to support their customers through these difficult times. BMO Bank of Montreal is one such institution, and has offered refunds, deferrals and other support benefits to clients in need. In many ways, the pandemic has strengthened the bank’s existing commitment to the wellbeing of its customers and employees.

The pandemic may well lead to permanent changes in the financial sector – ones that banks need to prepare for now. World Finance spoke with Michael Bonner, Head of Canadian Business Banking at BMO, about the measures the bank has put in place in response to COVID-19.

 

Has the pandemic changed your approach to business or clients?
So far, it has been an extraordinary year for all of us across the globe, with COVID-19 impacting all aspects of life, from the personal to the professional. Unsurprisingly, it has been a challenging time for many of our clients: while dealing with the personal effects of the pandemic, they have also been working to ensure a safe workplace for employees, customers and suppliers.

For BMO, the pandemic hasn’t changed our approach so much as reaffirmed it. We often talk about how the bank is great in good periods and even better when challenging times arise. This is clearly one of those times, and we have made it our priority to reach out to all of our clients to let them know we are here for them. Our focus hasn’t just been on the financial: we’ve held many virtual sessions for our business clients to provide guidance on how they can manage the various challenges of COVID-19. This includes access to economists and medical experts, as well as government officials who can help them navigate the myriad financial relief programmes available.

 

What has made you most proud of BMO’s response to the pandemic?
Our purpose is to boldly grow the good in business and in life; our employees across the bank quickly adjusted to ensure that our clients in both the US and Canada were taken care of. In record time, BMO launched a robust set of financial relief programmes for our clients and partnered with the government to facilitate federal relief programmes.

One thing the crisis has shown us is how quickly we are able to respond to change and remove barriers to innovation

Immediately, we had employees from across our teams working together to proactively reach out to our clients and ensure they were aware of the much-needed support. Within a matter of weeks, we had launched an online application with automated fulfilment. Through that system, we’ve funded over CAD 2bn ($1.46bn) and facilitated support for 56,000 clients.

Given that social distancing is not going away – only easing – we’ve also focused on helping clients sign up for direct deposits so government payments can be more easily accessed. What has also been exciting is seeing how many of our clients have been able to pivot to a new way of selling, either by adapting from a physical location to online sales or by producing new products. We’re pleased to have been able to guide them through the transition, and I’m proud of how our teams came together to support our clients.

 

Last year, we talked about BMO’s digital technologies and data. Have you seen a change in how your clients access your services in 2020?
Partly as a result of the unprecedented circumstances we find ourselves in, we’ve seen an uptick in digital engagement of about 15 percent over the past year. We need to continue driving innovation in this space – not just because of the crisis, but because clients are looking to bank on their own terms. It’s about convenience, customisation and control.

Technology enables success for both the bank and our clients. We’ve seen increased interest in all our digital solutions, from online applications and approval to e-signatures, quick bill payments and biometric authentication. One thing the crisis has shown us is how quickly we are able to respond to change and remove barriers to innovation. As our staff share their good ideas, we will look to launch them. The key is to continue focusing on what clients need, to be agile and to operate as one bank across multiple teams and specialities.

 

You’ve talked about BMO’s approach to client experience before. How are you using data and analytics to enhance your interactions with clients?
As a bank, we’re in a unique position in terms of the data and analytics available to us for businesses and industries. We’re starting to look at ways to use that information to offer a more personalised service to clients. That means looking at inputs relating to our industry, including products used by similar companies, to make recommendations to clients that enable them to grow their business at an accelerated and sustainable pace.

If using data in this way sounds impersonal, it’s not. For BMO, banking is a relationship-based business and we pride ourselves on being human in all we do. The real value of analytics is the client conversation it enables. By identifying the products and services that similar clients use, our salespeople can have more informed and helpful discussions with clients. We put insights into our workforce’s hands so they can help our clients choose better options for better outcomes.

 

Which industries does the bank focus on, and do you anticipate this changing in the post-pandemic environment?
We serve clients in all industries and specialise in areas where our clients value deep expertise. COVID-19 doesn’t change that, and we continue to see strength in areas of specific focus. We are the number one bank in Canada among indigenous businesses and we continue to put a focus on critical growth sectors such as healthcare and technology, which are currently experiencing transformational change.

In addition, we are about halfway through a three-year project to support female entrepreneurs, in which we have committed to investing CAD 3bn ($2.19bn). This has been one of the most impactful and satisfying investments we’ve made – to date, we’ve authorised about CAD 1.8bn ($1.32bn) of investment, and we are about 60 percent of the way through our original investment. The BMO for Women initiative has also had an impact on our own organisation, encouraging us to focus on ensuring representation at all levels of leadership.

Our growth priorities depend on our continued momentum in managing deposits and cash flow. Our strategy centres on winning profitable operating deposits by targeting industries that have significant deposit volumes and value great cash flow strategies.

 

What are BMO’s plans for the next year?
The Canadian economy’s resilience during this time is a testament to the strength of the small and medium-sized enterprises that are the bedrock of our business. This segment will continue to be our core focus, with exceptional client experience remaining our primary objective.

This year has cemented some of our most deeply held business beliefs: we truly believe that trusted advice is not a commodity, and we believe the choice of bank is one of the most consequential decisions a business owner can make. As partners, we help our clients manage their challenges and opportunities at every stage, whether they are building, growing, stabilising, expanding or selling a business. Our focus on client relationships is where we have built our brand and our strength, and that is where we will continue our leadership.

Carnegie at the forefront of navigating the global financial markets in the Nordics

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The COVID-19 outbreak is reducing global economic activity, weighing down the financial markets and heightening uncertainty. Drastic quarantine measures and partially closed borders are causing disruptions of historic proportions in global production chains. Fortunately, the Nordic business sector is well equipped to manage external disruptions and is at the forefront of new technology.

Before 2020, the number of Nordic initial public offerings (IPOs) had been at a historically high level. There is much to indicate that this will continue when stability returns to financial markets. Carnegie has taken the lead in the Nordics when it comes to using anchor investors, who commit to acquiring an agreed portion of the available shares. As a result, IPOs can still be executed when the listing climate is somewhat less favourable. Anchor investors raise transaction certainty and ensure high transaction quality. Further, good equilibrium prices are often achieved, giving an upside to new investors.

Access to risk-willing capital also remains good in light of low interest rates. This is particularly apparent in the demand for alternative investments in unlisted companies among Carnegie Private Banking clients. At this stage, companies often announce that they are planning an IPO within a few years and are thus in the pre-IPO stage. Investments in companies prior to buyouts or IPOs are often good investments.

The changing winds of public opinion and political tendency towards protectionism have restrained globalisation

The transformation of Nordic economies prompted by growing technology and biotech sectors has continued, and interest among companies seeking financing or an IPO was good at the beginning of the year. This reflects the dynamics of a business sector increasingly dominated by new entrepreneurs, business models and technologies. Tech and biotech are two areas showing growth in mergers and acquisitions at the European level. As digitalisation and automation continue to recast the business sector with unabated strength, climate issues and new technologies that address climate transition are climbing even higher up the agenda. Further, the issue will quickly take on greater urgency after the acute phase of the pandemic has passed.

 

A world divided
Globalisation – in combination with digitalisation – has been a dominant driver among economies and financial markets around the world for decades, especially since China and the former Soviet countries of Eastern Europe began to integrate into the world economy in the late 1980s.

However, the changing winds of public opinion and political tendency towards protectionism have restrained this trend. This is most obvious in terms of Brexit and the US’ ambitions under the Trump administration to move towards more bilateral, rather than multilateral, trade agreements. The trade war between the US and China, in particular, could lead to some regionalisation of the world economy, with the US and China becoming the focal points of two distinct blocs.

It now appears that the outbreak of SARS-CoV-2 will accentuate geopolitical tensions and trade conflicts. We are seeing signs of a technological cold war (a ‘decoupling’) in which the world is technologically divided into two spheres – American and Chinese. With this development, Chinese tech companies are becoming more of a risk factor for European industry, and national domicile is playing an increasingly important role for a growing number of companies.

When economic instruments are used to pursue geopolitical ends, globalisation is challenged as a megatrend and a dominant force in the world economy. Instead, signs of deglobalisation – during which global economic integration is at least partially reversed, moves backwards and loses steam overall – are emerging. The re-evaluation of trade relationships – not only between the US and China but, by extension, between other regions – is decelerating international trade and dampening economic growth.

 

Ongoing uncertainty
The upcoming US presidential election and the ongoing issue of Brexit are generating some political uncertainty in 2020, with the former likely to be a factor in the financial markets during the second half of the year. The answers to investors’ questions about what economic rules will apply between the EU and the UK will not come until late in the year, and several matters are likely to be postponed.

The Nordic equity markets have substantial exposure to global trends and risks, although the region’s economies are stable and public finances are robust. Nordic business sectors are also generally good at managing external disruptions, structural changes, new technologies and novel business models, which are creating investment opportunities in the region and have historically contributed to a vibrant corporate transaction market. Climate risks, sustainability and environmental, social and governance factors are also rapidly and steadily climbing up the priority list for companies and investors alike. Effective corporate strategy and implementation in these matters often leads to premium valuations of companies, as shown by Carnegie’s analysts. Nordic companies and stock exchanges are relatively far ahead of the pack here, and an assessment of the risks to a company from climate change is the latest example.

The European Commission’s Green Deal, which has a sharper focus on reducing greenhouse gas emissions, will create major opportunities for Nordic companies that are well-positioned with new technology and comprehensive sustainability programmes once the COVID-19 pandemic subsides and economic recovery arrives. Sudden economic and political changes that affect stock market sentiment put higher demands on portfolio management. Investors should, therefore, make sure their allocation is right. It is imperative to have access to proactive, committed and high-quality advisory and management.

In late January, we lowered the equity weight to ‘neutral’ in light of favourable stock market trends, high valuations and the growing uncertainty about the spread of the novel coronavirus – the capital freed up was invested in fixed-income assets. In March, our equity exposure was markedly reduced due to the stock market decline. We then chose to rebalance our portfolios by again increasing the equity weight at the expense of fixed-income investments. In hindsight, that was a wise decision: as a result of the upweighting, combined with a rising stock market in April, our equity exposure was once again rather large. We decided, therefore, to rebalance again in May by taking some of the profits from the market recovery and maintaining a neutral equity weight.

At present, we recommend a neutral allocation between Swedish and foreign equities. Foreign equities have performed somewhat better during the year when measured in SEK, mainly due to the strong development of US tech companies. Few clues indicate that either Swedish or foreign equities will have a clear advantage during the rest of the year: Carnegie Securities has cut its profit forecast for the large-cap universe in Sweden by more than 25 percent for 2020, but the consensus is that this loss will be regained in 2021. This is probably an optimistic assessment, as COVID-19 is both weakening demand and increasing costs.

When profit outlooks are this uncertain, equity valuation becomes very difficult. Looking at price-to-earnings ratios over the next 12 months, global equities are expensive, but interest rate support has been strengthened during the pandemic. The US Federal Reserve is going the furthest in this regard and is now buying corporate bonds.

 

Trends for the future
Following the credit market crash and the robust measures taken by central banks, we identified a seldom-seen buy opportunity in fixed-income investments. The investment-grade segment (bonds with high credit ratings) is the most interesting, but there are also selectively interesting opportunities in high-yield bonds (those with lower credit ratings).

It is important to note that we work globally on the fixed income side and, this year in particular, our decision to diversify away from the Nordic region has paid off. Liquidity on the fixed income side is poorer in the Nordic market and more concentrated in certain sectors, which is rarely a good thing in times of crisis. Our alternative investments have done better than our fixed-income ones this year and have not been as severely impacted by the coronavirus crisis. As such, we see a somewhat greater upside potential in fixed-income investments in the next few months.

In another distinct trend, an increasing share of corporate loan financing is ending up outside the traditional banking system, as banks must limit their lending. Corporate financing is instead being arranged through bonds or direct loans from providers outside the banking system, such as institutions and special funds. This may bring additional return opportunities for private banking clients. This trend is creating scope for private individuals and institutions to invest in debt instruments with relatively good returns, which are otherwise hard to find.

As before, the view remains that the best returns are found in the stock market. In our management, we are constantly looking for interesting thematic investments and associated investment products. Sustainable food, 5G, ‘antifragile’ assets, robotification and the pharmaceuticals of the future are examples of our current thematic investments. Tech is red hot and 5G is kicking the digital economy into next gear. Self-driving cars, the Internet of Things and e-health demand faster connections, shorter response times and better coverage.

These drivers are accelerating the transition of the agriculture and food sectors towards a greener, more sustainable future. This is creating exciting investment opportunities in areas including health food, agritech, animal and plant welfare, recycling and green packaging. Assets that are resilient to or strengthen during moments of turbulence are a desirable addition to a portfolio. The antifragile assets we are finding include certain government bonds, commodities, volatility products and currency positions, as well as certain equities.

Germany’s radical fiscal policy shift, and why it won’t last

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It’s no secret that Germany is a nation of savers. German households save about 10 percent of their disposable income, twice as much as the average American or European. This personal preoccupation with saving has been called a national obsession. Thrifty finance ministers are celebrated, not vilified. In Dusseldorf, a clock counts up how many years the country has been debt-free for. So when Europe’s largest economy announced a €130bn ($154bn) stimulus package to lessen the blow of coronavirus – one of the world’s largest fiscal responses to the pandemic – analysts balked at what looked like the end of Germany’s longstanding commitment to frugality.

“The U-turn German policymakers have made over the last couple of months is remarkable and significant,” said Carsten Brzeski, Chief Economist at ING. “Germany has moved from austerity champion to big spender. No more austerity fetish.”

The spending spree is nothing short of a radical departure from the fiscal stance Germany has held for over a decade. However, it doesn’t necessarily spell a new economic era for the country. In fact, it’s more likely the recent stimulus package will only vindicate policymakers who have long argued that Germany should tighten its purse-strings during good economic times, in order to prepare for the bad.

 

A history of frugality 
It could be said that frugality is embedded in the national character. “Even German households do not like to have debt,” said Alexander Kriwolusky, Department of Macroeconomics at the German Institute for Economic Research in Berlin. “People like to save and so they also would like to see the government save.”

This proclivity for saving is nothing new; it began centuries ago. The world’s first savings bank was founded in Hamburg in 1778. As early as 1875, over two million people in the German state of Prussia held a savings account.

Today, the much-loved symbol of austerity in Germany is the black zero or ‘schwarze Null’ policy, which refers to a balanced budget with no new government spending. The architect of this policy was Wolfgang Schäuble, Angela Merkel’s finance minister between 2009 and 2017, who introduced it to bolster the economy in the aftermath of the Eurozone debt crisis. Even while economic activity slowed in 2019, the government continued to cling to the black zero. It’s now been government policy for over a decade.

“A lot of people in Germany thought that this was a very sensible policy right coming out of the European debt crisis,” said Kriwolusky. “It became very popular in Germany over the last couple of years. It was highly regarded among Conservative voters. Even the Social Democrat Olaf Schulz – who has been the finance minister now for quite some time – kept it because it was so popular among the voters in Germany.”

Indeed, enthusiasm for this policy is even shared across political parties. “Once you put somebody from the Social Democrats into the office of finance minister, he miraculously turns into an adherent of the black zero that comes with the office,” said Holger Schmieding, Chief Economist at Berenberg Bank.

According to Schmieding, the recent stimulus package has only reaffirmed the conviction among policymakers that saving is the way to go. “We have always said we need to save for a rainy day,” he said. “Now that we have saved, we actually can afford to do much, much more than almost anybody else – except, in a way, the US with its dollar as the global currency.”

Schmieding also thinks that the burden of saving has not weighed too heavily on Germans’ shoulders. “All in all, Germany’s economic performance, while it brought its debt levels down, was actually fairly good,” he said, “and so the feeling over here is the policy was right. It didn’t harm us. It was not bad austerity which cost us dearly; for example, we had virtually no unemployment. And now we can afford – at very low interest rates, with a lot of fiscal credibility – to get into deficit for a number of years.”

 

Crumbling infrastructure
However, despite its popularity, the black zero policy has come under fire in recent years. Before the pandemic, Germany was already coming under pressure to provide extra fiscal stimulus, with borrowing costs sinking and foreign demand weakening. European leaders have been particularly critical of the country’s reluctance to spend more, since this impedes the economic output of the whole bloc; French President Emmanuel Macron said that Germany’s penchant for balancing budgets always occurs “at the expense of others”.

What’s more, Germany’s fiscal prudence means there has been very little investment in the country’s infrastructure. “The austerity of the last few years has eaten up the country’s economic capital with a lack of investments in digitalisation, infrastructure and education,” said Brzeki. At the end of 2019, its municipal investment backlog stood at €138bn ($152bn), according to the state development bank.

However, not all of this can be attributed to a lack of funds. Schmieding points out that Germany’s infrastructure problems are partly due to its limited construction capacity. “The biggest bottleneck in Germany on infrastructure investment for actually a long time – meaning for five years – has been the lack of available labour and available planning capacity,” he said. “It’s easy to say we want to have more infrastructure investment, but if you don’t find the Dutch or Polish company who actually repairs the bridges, we can’t. There aren’t enough German companies around to do it.”

In fact, far from failing to make funds available, Germany has struggled to spend the money it has allocated to infrastructure. At the end of 2019, unused funds stood at €15bn. “What we would like to see – and have started to see, to some extent – is an effort to streamline the procedures for approving projects and then hopefully finding the companies to actually do the job,” said Schmieding. “This is now being sped up and you could say that with the overall labour market weaker and with business investment being weaker, it is likely that in the future, we can actually do some of the infrastructure investment because we will have fewer construction companies working on other projects.”

It’s vital Germany addresses this gap soon, because its investment gap weighs heavily on business activity in the country. According to a poll by the German Economic Institute, two out of three companies in Germany say poor infrastructure is affecting their operations.

However, Kriwolusky doesn’t think the recent €130bn stimulus package is enough to rectify these problems. “Most of the stimulus package is related to the cut in the consumption taxes, some of it goes to firms so that they do not go bankrupt and then part only a small part of the package was related to these infrastructure investments,” he said, “and I don’t think that’s a sufficient amount. For example, I do not think that that’s sufficient to deal with these huge, huge efforts that are necessary in order to deal with climate change.”

 

Returning to the black zero
There has been a growing belief among economists that the lack of new spending is a major contributing factor behind the country’s low growth. According to the Federal Statistics Office, Germany’s growth fell to 0.6 percent in 2019, down from 1.5 percent in 2018.

Last year, patience with the black zero policy seemed to be seriously waning. In November 2019, Germany trade unions and businesses formed an unlikely alliance to call for a €450bn public investment drive from the government. Angela Merkel swiftly rejected the call. It was important to reduce debt during good economic times, she argued, and not saddle future generations with a heavy debt burden, particularly given Germany’s rapidly ageing population.

Kriwolusky believes the coronavirus will have revived the public’s faith in the policy. “In my opinion, it’s not the end of the era of the black zero. But it seems to be a short-term shift,” he told World Finance, “motivated by the lessons from the financial crisis. At that time, the fiscal stimulus package in Germany was quite successful for getting the economy back on track. The coalition government then was almost the same – it was also an Angela Merkel-led government of conservatives and Social Democrats. So I think they decided a huge stimulus package is what’s needed to get out of the recession because it worked so well 10 years ago.”

As a result of this new borrowing, Germany’s debt-to-GDP ratio has inevitably soared. The finance ministry has warned that debt could surge to 77 percent of GDP this year. However, Germany’s finance minister Olaf Scholz pointed out that, when Germany’s debt-to-GDP hit 81.8 percent after the financial crisis, strict budgetary policies meant it fell to below 60 percent relatively quickly.

That said, it may be some time before Germany is able to return to its frugal ways. Schmieding predicts that GDP won’t reach pre-coronavirus levels until late 2022. “Even for a strong economy like Germany, it will take two years after the trough – which is pretty much happening now – to get back to the previous level,” he said. “And even if we get to the previous level of GDP, it will still be partly because of more government spending. It will not be because private and business spending, household consumption and business investment is back to where it was. So it’s probably not until 2023 that we can talk of trying to balance the budget again. Of course, it all depends on politics. This is, I would say, the aspiration of the conservatives, not of whoever their coalition partner is.”

Germany has been able to harness public finances during the pandemic in a way that no other nation has. As a result, its economic recovery may be more rapid than its European neighbours’. Whereas Italy’s economy is expected to shrink 12.8 percent this year, according to the International Monetary Fund, Germany’s is expected to shrink by 7.8 percent.

But Germany won’t be the only beneficiary of its stimulus package. As the Eurozone’s largest economy, its spending spree bodes well for the future economic stability of the region as a whole. “This fiscal stimulus will not only strengthen the recovery and help bring forward structural changes to the economy,” said Brzeski, “but will also help further European integration.”

Sampath Bank helping Sri Lanka move in the right direction

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It’s no secret that modern banking is very different from what it was 33 years ago, when Sampath Bank first opened its doors as a private commercial bank in Sri Lanka. Since then, the organisation has become a powerful force in the local banking sector, establishing itself as the country’s third-largest bank with a robust market capitalisation of LKR 62bn ($333m) as of December 31, 2019.

Sampath Bank has been at the forefront of reshaping the national economy, proving a key contributor to Sri Lanka’s progress from a low-income economy to a middle-income and, subsequently, upper-middle-income one. The bank’s commitment to its Sri Lankan roots has enabled it to gain the trust of the public and claim a commanding share of the local market. These solid credentials have allowed it to remain resilient and well equipped to face even the severest economic headwinds.

 

Hard times
For the Sri Lankan economy, 2019 was another trying year as challenges continued to mount. Just as it appeared the economy was gaining much-needed momentum after months of sluggish growth, the Easter Sunday bombings in April shattered the socioeconomic fabric of the nation and left the country reeling. It should come as no surprise that economic activity took a nosedive in the months following the attack.

Although it was evident that the tourism, leisure, transport and logistics sectors bore the brunt of the impact, the cascading effect left most sectors facing bleaker prospects in 2019. The fact that it was an election year only exacerbated the situation, adding to the uncertainty and deepening discontent among the investor community. Lacklustre performance in all key sectors left the economy well short of last year’s GDP targets.

Last year can easily be labelled as one of the toughest 12 months in Sampath Bank’s 33-year history

On a positive note, subdued conditions facilitated the continuation of low inflation for most of 2019. Also commendable were the government’s tighter fiscal policy controls, which helped bolster Sri Lanka’s external sector. A moderate improvement in export earnings stemming from the reinstatement of Generalised Scheme of Preferences Plus concessions and the trade boost from US-China tensions contributed towards an improved external sector.

In yet another notable positive, Sri Lanka moved up the rankings to claim a spot in the highly coveted upper-middle-income category of the World Bank’s 2019 country classifications, which are based on per capita gross national income (see Fig 1). This no doubt points to the success of long-standing efforts by successive governments to raise the country’s socioeconomic profile.

Sri Lanka’s banking sector, which typically takes its cue from the country’s economic activity at any given time, experienced what can only be described as a turbulent year. Characterised by generally low aggregate demand and a diminished appetite for credit due to muted business activity, the earning potential of the banking sector shrank. On top of this, net interest margins came under pressure in the second half of the year due to the low-interest environment. And with widespread economic instability affecting businesses and individuals alike, the banking sector was left struggling to cope with the burden of higher non-performing loans (NPLs), which proved to be another major drawdown for the sector’s profitability.

Sri Lankan gross national income per capita
Sri Lankan gross national income per capita

This decline was reflected in terms of both return on assets before tax and return on equity after tax, which dropped to 1.4 percent and 10.3 percent respectively in December 2019, down from 1.8 percent and 13.2 percent the previous year. NPLs, meanwhile, had grown to 4.7 percent by the end of 2019, up from 3.4 in 2018.

In testimony to its underlying stability, the banking sector continued to maintain liquidity buffers that were comfortably above the minimum regulatory requirements. The statutory liquid assets ratio remained above the required level, while all currency liquidity coverage ratios were maintained at healthy levels well above the regulatory minimum of 100 percent.

 

Committed to the cause
Last year can easily be labelled as one of the toughest 12 months in Sampath Bank’s 33-year history. As weak credit appetite began to affect growth prospects, the bank’s management reinforced its commitment to moving in the right direction, albeit more cautiously. At the same time, it declared a year of consolidation, moving to critically investigate every aspect of its business model in a bid to reinforce bank-wide defensive mechanisms and improve Sampath Bank’s resilience against economic headwinds.

Several key priorities were identified, among them prudent risk discipline and a lean cost structure to safeguard performance outcomes. As a testament to the swift action taken, Sampath Bank reported pre-tax profits of LKR 15.5bn ($83.3m) and post-tax profits of LKR 11.2bn ($60.2m) in 2019. Although 15.5 percent and 8.2 percent lower than the figures reported in 2018, these results are nonetheless commendable in light of the challenges encountered during the year.

We also intensified our capital raising activities, showing a staunch commitment to maintaining the required capital buffers to comply with the Basel III requirements introduced by the Central Bank of Sri Lanka. By issuing its third successive Basel-III-compliant debenture in February 2019, Sampath Bank raised LKR 7bn ($37.6m) to augment its Tier 2 capital, while LKR 12bn ($64.5m) was raised by way of a rights issue in June 2019 to boost the Tier 1 capital position. A combination of these efforts ensured that Sampath Bank’s year-end Common Equity Tier 1, total Tier 1 capital and total capital adequacy ratio remained at a healthy 14.22 percent, 14.22 percent and 18.12 percent respectively – well above the minimum regulatory requirements.

Further, as competitive and regulatory pressures continued to build and the operating environment became more complex and unpredictable, a firm call to action to strengthen internal defences was seen as vital, specifically when it came to increasing Sampath Bank’s readiness to face the next decade and beyond. Our Triple Transformation 2020 (TT20) agenda, which was launched in 2019, marks the beginning of a long-term transformative journey to reform three core areas: business, technology and people. The bank hopes the TT20 agenda will create a solid foundation that allows it to move forward
over the next three to five years.

 

The road ahead
Our overall effort to build a stronger and better bank was supported by efforts to reinforce Sampath Bank’s oversight and leadership in certain strategic areas that are likely to play a pivotal role in our onward journey. Following a deep dive to measure the quality and capacity of our existing board structure, several new directors were appointed to augment the board’s capacity in terms of human resources and IT knowledge.

Sampath Bank in 2019

While strengthening its defences against external threats, Sampath Bank remained firmly anchored to its core purpose as a bank. This was exemplified by our ongoing digital transformation initiative, which was further accelerated in 2019 to migrate more customers to digital mediums that are altogether more convenient and easier to use. We have achieved several key milestones by increasing our investment in digital infrastructure to make our value proposition accessible to mainstream customers across Sri Lanka – notably, the release of our WePay wallet, which enables users to digitally make payments to hundreds of registered merchants across the country via their smartphone.

Not just another payment alternative, the WePay mobile wallet will likely serve as a powerful tool to expedite Sri Lanka’s journey towards becoming a cashless society in the years ahead. Another significant development was the appointment of more than 170 Sampath MYBANK agents, who were granted the authority to perform routine banking services with the help of a point-of-sale terminal that is digitally connected to the bank’s core system. These efforts demonstrate the bank’s digital superiority compared with its peers, but more importantly reflects Sampath Bank’s true purpose: to reach out to and serve all Sri Lankans across the country.

Despite having overcome the challenges of 2019 reasonably well, it is quite likely the bank will find itself facing even more hurdles in the years ahead, especially in light of the economic fallout arising from the COVID-19 pandemic. With the spread of the virus still evolving, the impact on core markets and the bank’s financial results cannot be accurately estimated at present. It can be reasonably assumed, however, that the impact will be unprecedented. Evidence suggests the spread of SARS-CoV-2 has caused widespread disruption to business and economic activities around the world – naturally, this will affect a large cross section of Sampath Bank’s clientele in various industries and sectors.

Moreover, the debt moratorium announced by the Sri Lankan Government to provide relief to individuals and businesses affected by the lockdown, along with the announcement of reduced interest rates, is likely to have far-reaching consequences, including a negative impact on the bank’s earnings, cash flow and liquidity position. Sampath Bank will remain vigilant, however, continually reviewing and updating its contingency plans and risk management measures as the situation evolves and taking the appropriate preventative action to mitigate the potential impacts before they materialise.

A bright future for Bulgarian banking sector

Posted on by itsupport

The Bulgarian banking system may be experiencing a period of relative strength, but this has not always been the case. In 1996, many of the country’s commercial banks had a negative aggregate net worth and low liquidity – due, in part, to challenges relating to Bulgaria’s transition from a centrally planned economy to a more open one. Policies imposed since then have addressed these problems, greatly improving bank capitalisation.

The COVID-19 pandemic has taught us to be more united and overcome hard times together

Today, Bulgaria’s economy is in a much more favourable position, benefitting greatly from EU membership while its banks sit on stable ground. One of those banks, Postbank, boasts nearly 30 years among the leaders of the country’s banking market and has been a driving force for innovation in recent years. The institution has a strategic place in Bulgaria’s retail and corporate banking sectors, managing one of the best-developed branch networks and modern alternative banking channels in the country.

Further, the bank is one of the market leaders regarding the issuance of credit and debit cards, housing and consumer lending, savings products, and financial products for small and large international companies in Bulgaria. World Finance spoke to the CEO and chairperson of the management board, Petia Dimitrova, about the bank’s recent activity and its plans for the future.

 

What is your overview of the Bulgarian banking sector last year, and what are your expectations for 2020?
Last year was very successful for the Bulgarian banking sector. Once again, Postbank showed excellent results and was an industry leader by many measures. The successful merger with Piraeus Bank Bulgaria – carried out in a record time of just four months – ranked us third in the country by deposits and credit portfolio for the end of the year.

The projections for 2020 are really dynamic. Given the ongoing coronavirus crisis, I believe the Bulgarian banking system is prepared, with all banks having posted good results in terms of stability and managing risk. One thing is certain: the COVID-19 pandemic has taught us to be more united (even from a distance) and overcome hard times together, becoming wiser and stronger in the process. During the recent state of emergency in Bulgaria, Postbank was among the first banks to respond, offering packages of measures in support of our clients. As a leading lender with great achievements and ambitions in the area of digitalisation, we implemented the Bank@Home campaign, which encourages consumers to stay at home and use Postbank’s already extensive digital channels to protect themselves and the bank’s employees.

 

What is the key factor behind Postbank’s success?
The primary factor is our employees, who are at the core of everything we do. Since its establishment, Postbank has been investing lots of resources and effort into creating the best consumer experience for its clients and shaping the best possible workplace for its employees.

To provide leading services to our clients, we have opened pioneering generation offices where customers can easily and comfortably use banking services, consult with experts and find the optimal solutions for their long-term plans. We intend to gradually renovate our entire branch network in the country over the next several years.

 

Can you elaborate on Postbank’s plans for 2020?
We will certainly introduce more innovations, products and digital solutions so that our clients can choose from a large range of services. Our main focus will remain the development of the bank’s digital instruments, as this is part of our strategy for optimal consumer experience. We will also focus on taking an individual approach to each client, as there is a concrete personalised solution for every need.

In 2020, we will maintain our strategic partnerships with various organisations in Bulgaria to contribute to the development of the community. For instance, we will continue our joint programme with global entrepreneurship organisation Endeavor to provide comprehensive support to businesses seeking to scale up their operations. Another priority will be our continued partnership with SoftUni (one of the most innovative universities in Bulgaria), where we are building the digital skills of future professionals by helping them realise their projects and providing them with opportunities for career development in our company.

Our team has always set itself lofty goals and managed to surpass them. This is possible because we can rely on a united team, numerous partners, rich experience and a long-term vision for development.