Nicolas Véron

Financial Statements: Russia's Economic Prospects amid its War in Ukraine

Updating upon a previous session on the same theme, during yesterday's session I hosted Iikka Korhonen and Elina Ribakova to discuss the current picture and outlook for the Russian economy. 

Now Is Not the Time to Confiscate Russia’s Central Bank Reserves

This blog post jointly authored with Josh Kirschenbaum was published by Bruegel on Monday (May 16). 

Since Russia’s invasion of Ukraine, all significant jurisdictions that issue convertible reserve currencies have acted decisively to freeze their respective shares of the international reserves of the Bank of Russia. As the costs of Ukraine’s resistance mount, there are increasing calls to confiscate these frozen reserves to finance Kyiv’s war and reconstruction effort, as well as sceptical counter–arguments. In the European Union, the Polish government has advocated confiscating the reserves, and has received support from EU foreign policy chief, High Representative Josep Borrell. This idea is seductive. It is also unnecessary and unwise.

The Bank of Russia’s reserves are public money, and thus altogether different from though occasionally conflated with the frozen assets of sanctioned Russians (often simplistically though conveniently referred to as oligarchs). Some oligarchs’ assets are presumed to have been ill-gotten, but they nevertheless benefit from the protections accorded to private property. Conversely, Bank of Russia reserves are public money that benefit neither from such protections nor, in the context of sanctions, from sovereign immunity. But their acquisition by the Russian state, in principle on behalf of the Russian people, cannot be generally assumed to have been illegitimate. The Bank of Russia’s frozen reserves, at around $300 billion across participating jurisdictions, are also substantially greater than the oligarchs’ frozen assets.

There are at least five, partly overlapping, reasons why Ukraine’s supporters should hold off from confiscating Bank of Russia reserves at the current stage of the war.

First, confiscating the reserves would not tilt the balance of tangible capabilities between Russia and Ukraine. This may be the most important point, given the urgencies of war. The debate on confiscation could distract from other actions that are actually urgent and consequential, such as reducing European oil and gas imports from Russia and providing direct financing to the Ukrainian government.

Unlike these, confiscating the Bank of Russia’s reserves would not further Ukraine’s immediate objectives in terms of ending the war and securing withdrawal of Russian forces, Russian recognition of Ukraine’s territorial integrity and a lasting peace agreement. Russia’s central bank’s foreign assets are already frozen, and moving from freezing to seizing them will not weaken President Putin further. Neither the US nor the EU are financially constrained to the extent that they would need to appropriate the Bank of Russia’s money to do what they have to do. For both, the obvious procedurally quick and legally ironclad option is to continue to transfer large sums of money from national treasuries to the government of Ukraine. The US Congress is in the process of passing a $40 billion package of additional security, economic and humanitarian aid for Ukraine, and the EU is considering a new round of joint bond issuance to fund its short-term assistance to Kyiv.

Less leverage

Second, if they confiscated the Bank of Russia’s reserves now, Ukraine’s allies would deny themselves options that could prove valuable in terms of offering Russia a way out or gaining leverage in future negotiations. Nobody knows what may be at stake in discussions with Russia – and with what kind of Russia – in developments still to come. In some scenarios, the possibility of returning the Bank of Russia’s reserves could be a powerful bargaining chip. Removing that option upfront makes little sense. It is possible, of course, that using the frozen reserves to finance Ukraine’s reconstruction ends up being the best option, but that point has not been reached yet.

Third, a unilateral US move to confiscate the reserves could introduce harmful disunity in the pro-Ukraine camp, whose consistency of purpose has been a major strength until now. Notwithstanding Josep Borrell’s opinion, it is unlikely a consensus could soon be reached among EU countries (not to mention other pro-Ukraine countries) on reserve confiscation, if only because of concerns about systemic financial stability and the international rule of law. The EU is also evidently more exposed than the US to direct Russian retaliation, given its geographical proximity, security vulnerability and density of economic linkages with Russia, even though many of these are being dismantled rapidly. US Treasury Secretary Janet Yellen has signalled that the US Treasury would only recommend confiscation of the Bank of Russia’s reserves if it was supported by America’s partners in the pro-Ukraine coalition. She is right: action by the US alone could erode trust, or even provoke material damage if it included extraterritorial provisions.

Fourth, confiscating Russia’s reserves could entail unnecessary risks to the strength and stability of the international financial system. Similar arguments were made about freezing the Bank of Russia reserves in the first place, and are pervasive in both Russia and China. It is too early to know for sure to what extent these arguments have substance. But moving from freezing to confiscation would be a more radical step in terms of the safe-asset status of foreign reserves. The implications would be uncertain even if one takes into account the enormity of Russia’s assault against international norms and its apparent war crimes.

Conceding the moral high ground

Fifth, at a more intangible but no less consequential level, confiscating Russia’s reserves would mean conceding some of the moral high ground the pro-Ukraine coalition has largely occupied so far. When the US and its partners talk about defending the international rules-based order, there are already many perceptions of hypocrisy and double standards, particularly in developing and emerging economies.

The key point here is one of principle: credibly standing for a rules-based order is worth more than the billions that would be gained from appropriating Russia’s money. Countries place their reserves in other countries trusting they will not be expropriated in situations short of being at war with each other – and the jurisdictions holding Bank of Russia reserves, even though they actively support Ukraine, are not currently at war with Russia. Russia’s breach of international norms, grievous as it is, does not justify unlimited punishment.

It is apparent that international reserves enjoy some protection under international law (as noted by Paul Stephan), even though this may not include sovereign immunity from judicial processes, as mentioned above, and precedents are scarce. The moral high ground is also worth defending in relation to Russian public opinion, even though the perceptions in Russia are currently distorted by massive and ruthless domestic propaganda. Seizing Russia’s collective property runs the risk of entrenching Russian perceptions that the opposite side’s aim is really to harm Russia, rather than to defend Ukraine. That is likely to favour a revanchist orientation of the Russian public, plausibly against the best interests of Ukraine, its allies and world peace.

Legal obstacles

Moreover, using sanctions to confiscate the Bank of Russia’s reserves while the US is not at war is likely to be illegal under US law – the 1977 International Emergency Economic Powers Act (IEEPA). The only case of confiscation of government assets through sanctions under IEEPA was in 2003, during the US invasion of Iraq. Prior examples would have used authority under legislation that can only be applied in wartime (the Trading With the Enemy Act of 1917). Neither the Afghan nor the Venezuelan case have precedent value in this debate: in the former, the disposition of the central bank’s reserves may be justified by a past ruling that found the Taliban liable to the victims of the September 2001 attacks; in the latter, there was no confiscation but rather a release of previously frozen assets to the government viewed by the US as legitimate.

Even if Congress passes new legislation to authorise confiscation of assets in situations where the US is not at war, it could be found to be unconstitutional in future court cases. Such an aggressive expansion of executive powers might even cause the US judiciary to revisit the deference it has historically granted the government when exercising blocking or other sanctions authorities. Also, with confiscation unshackled, a future US president may use the non-wartime authority in a reckless manner, for example in a trade or tariff dispute. Similar arguments can be made in the EU and elsewhere.

The choice is not between confiscation and complicity. Of course, things would change entirely if the US, the EU or other members of the pro-Ukraine coalition were to become belligerents themselves, and quite possibly also if there is dramatic escalation by Russia. For now, Ukraine’s supporters should weigh which options are most likely to achieve their goals, even if they are less emotionally satisfying in the short run.

Financial Statements: Understanding China's Stock Markets

In today's session, I hosted John Yasuda of Johns Hopkins University and Yeling Tan of University of Oregon and PIIE, to discuss the contradictions in recent Chinese stock market policies. 

Financial Statements: The New International Sustainability Standards Board’s First Proposals

Last Thursday's episode was dedicated to the first exposure drafts of International Financial Reporting Standards (IFRS) on sustainability-related disclosures, the inaugural activity of the newly established International Sustainability Standards Board (ISSB) under the IFRS Foundation. I hosted Sue Lloyd, the ISSB's Vice Chair, and Michelle Edkins, Managing Director at BlackRock. 

The EU should sanction Sberbank and other Russian banks as it ponders banning Russian oil and gas

This blog post co-authored with Joshua Kirschenbaum was published today by Bruegel and by the Peterson Institute; the latter also featured part of it as a PIIE Chart. 

The European Union (EU) had a vigorous early response to Vladimir Putin's aggression in Ukraine, aimed at disrupting Russia's financial system and economy. Ending EU imports of Russian hydrocarbons would be a powerful next step and is an absolute priority. But other actions can and should be taken now while an oil and gas ban is being debated. Specifically, the EU should extend harsh sanctions to most or all of the largest Russian banks, including the largest one that plays a central role in Russia's financial system, Sberbank. There is no good reason for the EU not to do so immediately.

On April 6, the United States Treasury announced full "blocking" sanctions on Sberbank and on Alfa-Bank, Russia's fourth-largest bank, meaning US entities cannot conduct any transactions with them, and their US assets are frozen. Together with previous actions announced on February 22 and February 24, this action largely or completely prevents six out of Russia's top 10 banks, representing more than 60 percent of total Russian banking assets, from conducting any transactions subject to US jurisdiction. While the United States could do even more, its actions are much more than equivalent EU actions. Of those same top 10 banks (leaving aside the Central Bank of Russia), the EU has blocked only four (not including Sberbank and Alfa-Bank), adding up to only a quarter of total Russian banking assets, as illustrated in the figure.

The notion of European timidity on banking sanctions may sound awkward, given how the EU has been rightly praised for its bold actions on the financial front, just two days after Russia's invasion of Ukraine on February 24. The sanctions on the Central Bank of Russia, applied by the EU together with the United States, the United Kingdom, Canada, Japan, and other jurisdictions, have shattered the myth of a financial "fortress Russia" and forced the central bank to raise policy rates and impose capital controls, with severe negative impact for Russian credit and growth prospects and notwithstanding Russia's single-minded effort to shore up the ruble.

When it comes to individual banks, however, the EU so far has concentrated its financial fire on only seven Russian financial institutions: VTB (Russia's second-largest bank by assets as of October 2021), Promsvyazbank (#6), Otkritie (#8), Sovcombank (#9), Rossiya Bank (#16), Novikombank (#24), and the investment company VEB.RF, which is not licensed as a bank but has assets that would place it in the top 10 if it were. Three of these were the targets of EU blocking sanctions on February 23, the day before the invasion. Then on March 1, the EU excluded all seven from access to SWIFT, the Belgium-based global payment messaging system. (Three Belarusian banks were added a week later.) Finally, on April 8, the remaining four also came under full blocking sanctions, which puts an end to a rather senseless loophole that allowed for the continuation of correspondent banking services without using SWIFT. These sanctions have been imposed by the entire EU (actually the European Economic Area), not just the euro area. But they leave the vast majority of Russia's banking system untouched.

Why has the EU been so cautious?

The initial round of sanctions on the central bank was without precedent for a country of Russia's size and systemic importance, and it may have been appropriate for the EU not to add further financial stress at the same time out of financial stability concerns. That motivation for prudence, however, no longer applies. The European Central Bank, in its role as euro area banking supervisor, has carefully monitored possible contagion channels and suggested, in a letter to European parliamentarians on April 6, that there is currently no reason for alarm from euro area banks' exposures to Russia. EU banks with large Russian operations have either signaled their forthcoming exit from the country, or in the case of Société Générale, announced it. All this considered, it does not appear that intensifying EU sanctions on individual Russian banks would materially threaten European financial stability.

The current EU stance of maintaining significant purchases of Russian oil and gas is not a reason to delay such intensification either. Put succinctly, EU buyers of Russian hydrocarbons do not need Sberbank to purchase the stuff. They can operate through a much narrower banking channel, either one Russian bank (large or small) that is left unsanctioned for that purpose, or even through a sanctioned bank using an authorized facility carved out of sanctions to allow oil and gas transactions. That bank may be Gazprombank (and/or its cousin the Russian Regional Development Bank, an affiliate of Rosneft), or another institution as may be deemed fit. Even assuming that some ongoing oil or gas supply contracts are currently serviced through Sberbank (or Alfa or another bank that has not yet been on the EU sanctions list), that banking relationship can presumably be switched to another institution without that constituting a breach of contract. Funnelling all energy sales through one approved banking facility (or a small number thereof) will have the added benefit of making monitoring of volumes easier across the EU, increasing the likelihood that member states will agree and adhere to reductions, if not the elimination of imports in the near future.

If the Russian authorities take that as a pretext to stop deliveries, so be it—but that risk exists no matter what, even though the late-March test of will over the separate issue of payment in rubles suggests it is rather low. In order to prevent humanitarian damage from the sanctions on banks, and to preempt Russian propaganda blaming the EU for imaginary such impact, the regime should include "humanitarian channels"—approved facilities set up to facilitate the sale of medicine, medical devices, and food- and agricultural-related goods from the EU to Russia. Additional channels could be provided for entities from non-EU countries to keep buying from Russia, even if the Russian bank involved in the transaction has been cut off from SWIFT; in that case, they would only need to use a different, presumably less efficient, messaging system.

Imposing blocking sanctions on Sberbank and the other large Russian banks currently left untouched by EU sanctions—namely Alfa-Bank, Russian Agricultural Bank, Credit Bank of Moscow, Bank Saint Petersburg, Tinkoff Bank, and more—may not dramatically change the environment of Russia's economy and would definitely be a less momentous decision than stopping EU oil and gas purchases from Russia. Even so, it would create pervasive impediments to hitherto unsanctioned international business for a wide range of economic actors in Russia and would also make it incrementally more difficult for Russian entities to circumvent some of the other sanctions already in place. Importantly, it can be done without delay, and at no major cost to the EU or like-minded countries. Given the atrocities committed by Russia and its disruption of Europe's fundamental security norms, there is much more risk in doing too little than in doing too much.

The authors gratefully acknowledge Egor Gornostay's help with Russian balance sheet data. Graphic design and production by Nia Kitchin and Oliver Ward.

Financial Statements: Ukraine’s Wartime Economy and Financial Resilience

In today's session, I hosted Valeria Gontareva, former governor of the National Bank of Ukraine between 2014 and 2017 and now a senior fellow at the London School of Economics, and PIIE's Patrick Honohan to discuss Ukraine wartime financial position and prospects. 

Putin’s Russia is a Minnow Compared to the Cold War Soviet Bloc

This blog post was published today by Bruegel, and yesterday by the Peterson Institute in their PIIE Chart series. The Bruegel version has interactive graphics from which the charts below are copied and pasted. 

It has become commonplace to analyse Russia’s invasion of Ukraine, and its antagonism with the United States and its pro-Ukraine peers, through the prism of the Cold War. This framing makes sense, but it is important to keep in mind that today’s bloc centred on Russia, even including Belarus and Syria, is much smaller than the Soviet Bloc used to be.

The following charts are based, for the late Cold War era, on membership of the Council for Mutual Economic Assistance (Comecon) and Non-Aligned Movement, and for the present moment, on United Nations General Assembly (UNGA) votes on the war in Ukraine (see methodology note below). At the end of the Cold War, the Soviet Bloc represented 9% of the world’s population and 10.5% of its economy, measured at purchasing-power parity (PPP). The equivalent numbers for Russia and its allies (the ‘Putin Bloc’) in 2020 are 2.5%  and 3.5%. If measured at market exchange rate, even before accounting for the ruble’s recent depreciation, the Putin Bloc’s share of GDP is even lower: 1.8% versus 6% for the Soviet Bloc at the end of the Cold War. The Putin Bloc’s population is about 60% lower, at 197 million, compared to 483 million in 1990 for the Soviet Bloc. This is the combined result of reduced geographical scope, and of the remaining group’s declining demographics and poor economic performance.

In these charts, China is counted in the Soviet-unfriendly group at the end of the Cold War (even though the China-Russia relationship was at an early stage of revival with Mikhail Gorbachev’s visit to Beijing in 1989, and the Tiananmen crackdown had temporarily cooled the China-US relationship). In 2020, China is counted among the fence-sitters, based on its UN voting behaviour. That could change of course, with opinions varying on that critical matter. But for the time being at least, based on the non-military metrics considered here, Moscow’s global heft is a shadow of its former Soviet self. 

 

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Note on methodology and data: GDP is computed at purchasing power parity, as estimated by the World Bank. End of the Cold War data is for 1990. The Soviet Bloc at that date is defined as the member countries of the Council for Mutual Economic Assistance (Comecon). For the present, the Putin Bloc is defined as the five countries that voted against the latest UNGA resolution asking Russia to immediately cease hostilities in Ukraine, adopted on 24 March 2022. ‘Fence-sitters’ at the end of the Cold War are the countries that attended the summit of the Non-Aligned Movement held in Belgrade in September 1989 (minus Cuba and Vietnam, since these were also in the Comecon). For the present, it is the countries that either abstained from or did not vote on the 24 March UNGA resolution. The ‘Soviet-unfriendly’ and ‘Putin-unfriendly’ groups refer to countries that do not belong to the previous two groups. For the present, that means all countries that voted in favour of the 24 March UNGA resolution. Non-UN-represented dependencies are included with the sovereign jurisdiction on which they depend, eg Hong Kong with the United Kingdom at the end of the Cold War and with China now. Countries that have become independent since 1990 are disaggregated for the present, but counted with their predecessor at the end of the Cold War, eg South Sudan. Germany is divided schematically at the end of the Cold War: one-fourth of the German population and GDP are attributed to the German Democratic Republic, and the rest to the Federal Republic. World Bank GDP data has gaps, including not providing data for Taiwan, but these are too small to significantly alter the aggregates presented.

Is the private sector retreating in China? Not among its largest companies

This blog post, co-authored with Tianlei Huang, was just published by the Peterson Institute and is based on our simultaneously published working paper on China's largest companies. 

Update (April 1): the Peterson Institute highlighted the first chart below as a PIIE Chart. 

Update (April 5): a lightly modified version of the same text was just published by Bruegel, together with their version of the working paper. 

Update (April 7): a slightly abridged version was published today by Caixin. 

Update (April 22): Caixin also published a version in Chinese. 

China's wave of regulatory restrictions on private-sector businesses in 2021 has been widely interpreted as reflecting a decisive turn, driven by President Xi Jinping for several years, toward a new economic regime with a greater role played by state-owned enterprises (SOEs). But is China's private sector truly being crushed? Evidence presented in a new PIIE Working Paper tells a different story—that among China's largest companies, the private sector is expanding rapidly and at a faster rate than SOEs.

The new PIIE paper has collected and analyzed data on the changing shares of the state sector and the private sector among China's largest companies for more than a decade. The data show that China's private sector has grown not only in absolute terms but also as a proportion of the country's largest companies, measured by revenue or (for listed ones) by market value, from a very low level when President Xi was confirmed as the next top leader in 2010 to a significant share today. SOEs still dominate by revenue among the largest companies, but their preeminence is eroding. To be sure, the Communist Party has attempted to develop its presence in the corporate world, including in the private sector, through various means. But equity ownership structures matter. China's private-sector companies are focused on profit maximization and value creation in ways SOEs are not.

The Chinese idiom "state advances, private sector retreats (国进民退)," which has been widely used to describe China's economic trends does not, therefore, represent the main picture of what has been going on under President Xi in China's business world so far, even in the most recent years.

Rapid Rise of Private Sector among China's Largest Companies

Unlike in most countries, shares of many of China's largest companies are not listed on a stock exchange. That is the case for the state sector as well as the private sector, even though many unlisted SOEs have much of their activity conducted in their majority-owned listed subsidiaries. Thus, the paper examines both listed and unlisted companies, using two partly overlapping rankings of China's largest companies.

The first sample is ranked by revenue, a proxy for a company's activity. The data derive from the research conducted by the business magazine Fortune for its yearly Fortune Global 500 ranking, from which the paper extracts the companies from mainland China. This group has grown fast, from 15 companies in the 2005 ranking (based on 2004 revenue) to 130 in the 2021 ranking (based on 2020 revenue). Their aggregate revenue grew from $2.8 trillion in 2010 to $8.8 trillion in 2020, a similar rate as the expansion of China's nominal GDP, which reached nearly $15 trillion in 2020.[1] Their aggregate headcount was 21 million in 2020, slightly under a twentieth of China's total urban employment, a ratio that has been fairly stable over the past decade.

The paper's second sample is limited to mainland Chinese companies whose shares are listed on a stock exchange, typically in Shanghai, Shenzhen, Hong Kong, and/or New York, including companies like Alibaba and Tencent that have adopted variable-interest-entity arrangements to circumvent China's onerous regulations on foreign ownership in certain sectors such as internet services. The paper constructs yearly top 100 rankings of Chinese listed companies from 2010 through 2021, based on year-end market capitalization. Their aggregate headcount and revenue levels are significantly lower than those of the first sample, as would be expected since they do not include some gigantic yet unprofitable unlisted SOEs, and conversely they include some high-growth young companies that hold much promise but are still relatively small. Together, these largest 100 listed companies represent about two-fifths of the entire market capitalization of all Chinese listed companies.

The ownership of these largest Chinese companies involves a range of investor categories. These include, among others, the Chinese state at the central and local (e.g., provincial or municipal) levels, directly through government ministries or departments (such as the Ministry of Finance of the central government) or indirectly through specialized agencies (such as the State-owned Assets Supervision and Administration Commission or SASAC at the central and local levels), state investment entities (such as Central Huijin Company, China Securities Finance Corporation, and the National Integrated Circuit Industry Fund), or SOEs that mix commercial and investment activities (such as China National Tobacco Corporation); founders and/or their relatives, management, and corporate pension funds of private-sector companies; private-sector companies like Alibaba and Tencent acting as venture capitalists; and foreign investors, e.g., diversified entities like Japan's Softbank or Thailand's Charoen Pokphand, and global asset managers like BlackRock or Canadian pension funds.

The paper includes case studies to illustrate the diversity and complexity of ownership patterns of some prominent Chinese companies such as Ping An of China and ZTE. It also has two appendices that detail the latest rankings (respectively, of Chinese companies in the 2021 Fortune Global 500 ranking and of Top 100 listed Chinese companies as of end-2021) with indication of each company's most significant shareholders.

For the purposes of this study, the private sector is defined as those companies, labeled "nonpublic enterprises" in line with Chinese practice, in which state entities hold less than 10 percent of equity capital. Within the state sector, a distinction is drawn between SOEs, in which the state owns a majority stake, on the one hand, and "mixed-ownership enterprises," in which the state holds only a minority position, i.e., between 10 and 50 percent, on the other hand. The methodologies, as well as numerous additional findings, are presented in detail in the paper.

These definitions refer to equity ownership, leaving open other, less easily quantifiable notions. The Chinese Communist Party is clearly striving to develop its influence in China's private sector, even though that influence remains considerably less direct than among SOEs. It would be an exaggeration, however, to say that China is unique in this respect. Government influence occurs with the private sector in Europe, Japan, South Korea, Taiwan, and other advanced economies—even occasionally in the United States. Such influence is surely greater in China, but that does not erase the importance of the divide between the state sector and the private sector. Ownership matters greatly for economic development outcomes, even under pervasive Party control of political matters. The advance of the private sector, which the paper documents, is thus of structural significance for China.

With these definitions in mind, figures 1 and 2 illustrate the rise of the private sector among China's largest companies, measured, respectively, by revenue (all companies) and market value (listed companies). As is clear in figure 1, SOEs still dominate by revenue among the largest companies, much more so than in the Chinese economy as a whole. But the share of the private sector has been steadily rising, from zero in the mid-2000s to 19 percent of the total ($1.7 trillion out of $8.8 trillion) in Fortune's 2021 ranking, which is based on 2020 revenue.

As for market value of the largest listed firms (figure 2), the private sector represented merely 8 percent in 2010 but soared above the 50 percent threshold in 2020, and retreated only slightly in 2021, to 48 percent. Thus, the state crackdown in 2021 on certain private-sector-dominated industries, such as internet platforms and after-school tutoring, has had some impact but stopped well short of reversing the prior advance of the private sector using the market value indicator.

Figure 3 shows similar rising trends for other metrics, based on the same respective samples of companies.

Not Privatization, but Displacement of SOEs by Better-Performing Private Firms

The advance of the private sector among China's largest companies does not appear to result from long-term planning or top-down decisions, but rather from bottom-up dynamics. Deng Xiaoping, the Chinese leader who was the main architect of China's embrace of markets starting in 1978, had predicted in 1980 that "whatever the proportion of the private investment will be, this will cover only a small percentage of the Chinese economy. It will by no means affect the socialist public ownership of the means of production." In the 1990s, facing the need to restructure the loss-making state sector, China under Premier Zhu Rongji made a deliberate choice to keep the largest concerns under state control, even as many smaller SOEs were liquidated or privatized. That policy became widely known by the four-character idiom "grasp the large, let go of the small (抓大放小)," preserving "public ownership as the mainstay (公有制为主体)" of China's economic model. In line with these choices, the first large Chinese companies to enter global corporate rankings, whether by revenue or by market value, were all from the state sector until the late 2000s.

Privatization has been virtually nonexistent among China's largest companies. Nor has the state gone out of its way to confer a comparative advantage on the private sector. On the contrary, President Xi declared in 2016 that SOEs must become "stronger, better and bigger." What explains the observed trend, instead, is that private-sector companies have been more dynamic and profitable than those in the state sector. What PIIE scholar Nicholas R. Lardy has described as the "displacement of SOEs" by private-sector companies has occurred despite a policy environment that clearly does not favor them.

The emergence of private-sector champions reflects the spectacular growth of internet content and e-commerce platforms, but also other areas where the private sector is strong, including manufacturing (e.g., electronics, electric cars, batteries, steel, and chemicals), consumer products and services, pharmaceuticals, and life-science companies. Some of the largest Chinese property developers are also private, though the real estate sector is currently ailing with the shakiness of China's property market and the failure of Evergrande among other developers. By contrast, financial services, telecoms, energy, and transportation remain dominated by SOEs. But the growth of large companies in those state-dominated industries has been comparatively less rapid. In terms of market value, some have even declined in absolute terms, e.g., telecoms and energy.

Of course, the structural trend of private-sector advance, which has characterized the decade of China's development under President Xi so far, may not be a guide to what will happen next. But claims of a pivot back to state-sector dominance have been made multiple times before, with reference to policy shifts in 1989-1990, 2003, the mid-2000s, 2008, 2009, 2010, 2012, 2017, 2019, and early 2020. Meanwhile, China's private sector has kept advancing. There is no compelling indication that this time is different.

1. Whereas it makes sense to compare the respective growth rates, the companies' aggregate revenue is not a measure of their value added or collective contribution to GDP, and thus cannot be directly compared with GDP figures.

The private sector advances in China: The evolving ownership structures of the largest companies in the Xi Jinping era

The Peterson Institute just published a new Working Paper in which Tianlei Huang and I observe the evolving ownership patterns of China's largest companies over the decade-long period since Xi Jinping took over. Click here to download in PDF format in case the previous link is broken. 

In contrast to a cliché narrative of the Chinese state crushing the private sector, we find that this period has actually been the first time since 1949 of significant private-sector inroads into the higher ranks of China's corporate sector, not due to particularly favorable policy (we don't question the fact that SOEs are favored by many government decisions) but rather thanks to the remarkable entrepreneurial dynamism that continues to exist in China.

The paper is based on novel analysis of company-level disclosures which does not rely at all on Chinese official statistics. Two overlapping datasets are used: one of the 100+ largest Chinese companies by revenue, based on Fortune Global 500 rankings; and the other of Top 100 largest Chinese listed companies by market capitalization, irrespective of listing venue (e.g. Shanghai, Shenzhen, Hong Kong, New York) and including variable-interest-entity arrangements such as Alibaba's. In both cases, we find a steady increase of the relative share of the private sector against that of the state sector, even though we use a conservative definition of the former - any company in which the Chinese government owns more than 10 percent of equity capital is considered state sector under our methodology. 

Update (April 5): the same research was just published by Bruegel in its own Working Paper series. Click here to download in PDF format in case the previous link is broken. 

Financial Statements: How Russia’s War in Ukraine Affects the Financial Sector

In today's session, I hosted Sergei Guriev (Sciences Po Paris) and Jacob Funk Kirkegaard (PIIE & GMF) to discuss the prospects for the Russian economy and the broader financial impact of the invasion of Ukraine. 

Six reasons why backstopping Russia is an increasingly unattractive option for China

This blog post co-authored with Alan Wolff was published today by Bruegel. 

Since Russia invaded Ukraine on 24 February, China has been ambiguous about its position on the conflict, while providing rhetorical support for the Russian narrative. At the United Nations, China stands out as the dominant economy that has not declared itself either against or in favour of Russia’s onslaught. It is clear China will not align with the NATO-led pro-Ukraine camp. But the opposite extreme, of providing a backstop to Russia’s war effort, is becoming increasingly unattractive for China. Even though we cannot predict which way China will go, there are a number of self-interested reasons why it should adopt a constructive stance on Ukraine’s future and global stability.

While the relationship between China and Russia has been through historical ups and downs, it has become notably close in recent times. The much-publicised meeting between Xi Jinping and Vladimir Putin at the start of the 2022 Winter Olympics showcased a strong political partnership, while Russian troops were massed on the border of Ukraine. Plausible accounts suggest that Moscow informed Beijing in advance of its intent to attack Ukraine, if not of the full scope of the prepared invasion.

Significantly, these accounts imply that the Chinese leadership, like its Russian counterpart, anticipated a lightning conflict that would quickly lead to a Russian-dominated Ukraine, enabled by a divided West. In fact, Ukrainian resistance has been fierce, and the United States, the European Union and other countries accounting for most of the world economy have shown resolve in their support for Kyiv. The degree of hostility throughout much of the world to Russia’s indefensible aggression and its apparent war crimes threatens to spread to any of those seen to be allied with Moscow. Meanwhile, the Russian military performance has been underwhelming and the war is unlikely to come to a conclusion any time soon.

Six good reasons

While it is plainly impossible to observe the Chinese leadership’s decision-making process from outside, let alone to make predictions about its outcome, it is possible to identify parameters that are likely to play a role in Beijing’s calculations. None of these point towards China gaining any benefit from aligning more closely with Russia. On the contrary, doing so would have clear costs.

First, China in recent decades has displayed a preference for stability. Its primary engagement with the world at large has been as a trading partner and major investor in infrastructure. As the war grinds on, the invasion of Ukraine looks increasingly like a reckless gamble that will disrupt and break many relationships, including trade and financial ones. By supporting Russia, China can only prolong the conflict, actively contributing to continued destabilisation of the international order. A return to stability can only come with an early peaceful resolution in Ukraine.

Second, China has promoted a geo-economic vision for Eurasia, in which it stands at the eastern end of a trading network that extends all the way to Western Europe. China has invested heavily in its relationships with the countries to its west, including Russia and Ukraine. With the EU now firmly on the side of the Ukrainian government, the new reality is that Ukraine will emerge more closely integrated with the rest of Europe. If China stands on the Russian side in a prolonged conflict, it would undermine its Eurasian vision of the Belt and Road.

Third, China has a longstanding diplomatic doctrine that emphasises five “principles of peaceful coexistence”: mutual respect for sovereignty and territorial integrity; mutual non-aggression; mutual non-interference in each other’s internal affairs; equality and mutual benefit; and peaceful coexistence. A quick Russian operation that delivered a stable puppet government in Ukraine could have allowed China to formulate a narrative in which these principles were upheld, but the evidence of Ukrainian patriotism in a war of resistance renders this impossible. To be seen to be discarding the foundational principles of its diplomacy would be costly for China, not least in its relations with its Asian neighbours.

Fourth, China wants to reunify Taiwan with the mainland. A quick Russian victory in Ukraine might have provided support for a Chinese strategy of seizing the ‘23^rd province’ by force. By contrast, a protracted conflict in which the Ukrainian side achieves impressive feats of resistance is a reality from which China may want to distance itself as much as possible. By propping up Russia, China could solidify the pro-Ukraine camp into a durable coalition that could provide a similarly unified response to any Chinese move against Taiwan.

Fifth, China is energy-dependent. The oil price inflation resulting from the war in Ukraine is bad news for the Chinese economy – even assuming it can buy more oil and gas from Russia at a discount. Furthermore, the war-induced price increases in commodities such as wheat, which are basic to the well-being of many developing countries, could subtract from the goodwill built up via the Belt and Road Initiative if China’s actions are viewed as prolonging the conflict.

Sixth, China’s extraordinary growth has been critically supported by access to markets and a continuing flow of international investment. Were China to materially support Russia’s aggression, the pro-Ukraine camp’s sanctions could begin to apply to Chinese interests. Russia’s increasingly murderous attacks against civilians add to the challenge. If China supports Russia, the implied reputational damage may lead to boycotts and lost investment, not to mention moral revulsion among the Chinese population as well. A scenario of significant decoupling of pro-Ukraine countries from China would do direct harm to China’s economic interests.

Balance of interests

Providing support for Russia might allow China to acquire some Russian assets on the cheap, but the Chinese leaders know this would be unpopular with the Russian public and could generate a dangerous political backlash. Worse, China would be faced with a Russian expectation of massive economic assistance, with uncertain likelihood of repayment.

To be sure, even if China recalibrates its balance of interests, it will not join quickly with the US and EU in supporting Ukraine. China has recently been the target of US and European sanctions, and of US tariffs. It bears scars from what it views as over a century of domination and humiliation by the West and Japan, from 1840 to 1949. But China has also become too large and visible to maintain a neutral stance. It can deprive Russia of support without ostensibly coordinating its action with the United States. Chinese rhetoric and propaganda may continue to take Russia’s side on the initial causes of the invasion. But what China does is more important than what it says.

Time is not on China’s side in terms of offering support to President Putin. Continuing Russian atrocities against civilians in Ukraine will be further enabled if China sides with Moscow. That would increasingly derail a return to the conditions that made China’s economic growth possible – a global trading system based on non-discrimination that welcomed China as a participant. A misreading of the pro-Ukraine camp’s resolve could impair China’s economic prospects to an extent that cannot be possibly offset by reliance on domestic (or Russian) demand. Rather than the US rolling back some of the Trump-era anti-China tariffs, these could become a foundation on which new restrictions are built, and could be emulated by other economies.

China has demonstrated pragmatism over time in building its economic position in the world. Prolonging its embrace of Russia would be a major misstep, with likely massive economic costs.

Financial Statements: The Trade-offs of Central Bank Digital Currencies and the Digital Euro Project

In this week's session (on Wednesday 9 March), I hosted Ulrich Bindseil of the European Central Bank (and author of the mesmerizing Central Banking Before 1800) and Natasha de Terán, coauthor of The Payoff, to discuss the pros and cons of central bank digital currencies (CBDCs) with a particular focus on the euro area. 

War in Europe: The Financial Front

This blog post, coauthored with Josh Kirschenbaum, was published on Monday by both Bruegel and, in a marginally different version (below), by the Peterson Institute. 

Since Russia's invasion of Ukraine started on February 24, much has happened in the financial sector, and events keep unfolding at a rapid pace. At the time of writing, Russia is reeling from the impact of massive financial sanctions inflicted by a very broad pro-Ukraine coalition. The Ukrainian financial system is battered but remains functional; and the European Union (EU) financial system has rather easily absorbed the initial shock, as has the global financial system more broadly.

Because it is war, it is impossible to convincingly disentangle what is happening on the financial front from the broader, primarily military-driven environment. We also do not analyze here other major economic developments, such as trade policy measures and withdrawals from Russia by nonfinancial companies. Even so, the financial sector action has been broad enough to deserve specific attention.

The pro-Ukraine camp's financial sanctions have included three main planks. First, a dramatic expansion of sanctions against specific Russian individuals. Second, a series of sanctions against individual Russian banks, including—but far from limited to—the much-hyped ability of the EU to mandate their disconnection from SWIFT, the international interbank messaging system which is based in Belgium and thus under EU jurisdiction, now also known as "de-SWIFTing". And third, the incapacitation of the Central Bank of the Russian Federation's (CBRF) use of its international reserves in a number of jurisdictions that critically include the US, EU, UK, Canada, Japan, Australia, and Switzerland, namely all the core reserve-currency jurisdictions of the world bar China (China's share of the world's aggregate central bank foreign reserves remains in the low single digits, even though its share of the CBRF's reserve is significantly higher). The third action, targeting the CBRF, unambiguously counts as systemic and affects the entire Russian financial system and economy. The first is about individuals. The second occupies a middle ground: If only a relatively small share of Russian banks is affected, it is nonsystemic, but if most are, it becomes systemic. From that standpoint, the EU's de-SWIFTing actions are still nonsystemic, since only seven institutions representing about a quarter of the Russian banking system are on the latest list. More could follow, however. In addition to these governmental decisions, some key financial firms are restricting their Russian services on their own initiative, such as VISA and MasterCard, adding to the general disruption.

The impact of the systemic CBRF-targeted sanctions on Russia's currency and economy is devastating, in part because they were so unexpected, and despite the continued ability of Russia to achieve a current-account surplus as long as it keeps exporting hydrocarbons. In the past, the United States has sanctioned other central banks, e.g., in 2019 Venezuela and Iran. What has never happened before, however, is coordinated action by all Group of Seven (G7) jurisdictions against a central bank, let alone one as large and internationally active as the CBRF. In fact, none of the 63 central banks that are members of the Bank for International Settlements (BIS) in Basel has ever been the target of financial sanctions. The CBRF is a member not only of the BIS club but also of its more exclusive subsets, e.g., the Financial Stability Board or the Basel Committee on Banking Supervision. It was hard to anticipate that it could be blackballed so promptly. Astonishingly for observers of the ostensibly soft-spoken, consensus-driven central banking community, the BIS announced on February 28 that it would itself follow sanctions "as applicable," which was widely understood as alignment with the G7 stance. This has no precedent since the establishment of the BIS in 1931, even during World War II. In recent years, the CBRF had diversified its international reserves away from US dollars and British pounds, but largely into euros (as well as Chinese renminbi and gold). In other words, it appears that the scenario that unfolded on February 26 had not featured on the risk map that underpinned the build-up of financial "Fortress Russia" since the invasion of Crimea in 2014. In hindsight, this was a clear miscalculation by the CBRF's otherwise highly competent governor and her team.

Ukraine, by contrast, is being devastated physically by the Russian military aggression, but is still very much standing financially. On March 1, the Ukrainian government issued $270 million in war bonds; since February 24, the country's central bank has benefited from a swap line of the National Bank of Poland, granting it a degree of access to international liquidity; more powerful assistance could come in the future from the International Monetary Fund, and possibly also from the European Central Bank, even though the latter is far from sure at the time of writing. In the war zones, of course, financial services are disrupted, as is everything else.

In the European Union, the initial shock has already been largely absorbed by the safety cushions created since the previous great financial crisis—thank goodness for Basel III. The presence of Russian banks in the EU is being promptly terminated in an orderly manner. The largest such entity, Sberbank Europe AG in Austria, has been liquidated in the immediate aftermath of the invasion after its Russian parent decided not to give it liquidity support; the second-largest, VTB Bank (Europe) SE in Germany, is likely to go the same way. On the other side of the divide, several EU banks, most prominently including Raiffeisen, Société Générale and UniCredit, have substantial operations in Russia and other financial exposures to its economy. Their stock price has suffered, but not collapsed, and it currently appears that their capital base is sufficient to absorb the shock. Unexpected damage could surely pop up in other corners of the system. But that risk does not currently appear large enough to threaten financial stability at a systemic level.

What happens next is, of course, anyone's guess and will keep depending on military developments. Further escalation of financial sanctions is possible. For example, the EU could de-SWIFT more Russian banks—possibly including Sberbank, which is already subject to harsh US sanctions, namely a correspondent accounts cutoff that prohibits it from clearing payments through the United States. The EU could also sanction Russian banks more strongly, e.g., banning all transactions with them and freezing their assets (full "blocking" sanctions) as the United States already does, for example, with VTB. Perhaps most important, pro-Ukraine jurisdictions could move towards banning energy purchases from Russia, which are currently allowed under their respective financial sanctions regimes.

On a more long-term, structural basis, only time will tell if the recent action against Russia has contributed to strengthening the international financial system, by punishing destructive behavior, or fragmented it into increasingly decoupled competing blocks. It bears noting, once again, that the recent financial sanctions have been far from unilateral, but on the contrary have been adopted, certainly with local variations, by an extremely wide group of financial jurisdictions that goes beyond "the West." Russia's transgression of international norms is so radical that it remains to be seen to which extent the international response to it, radical as it has been as well, has precedent value.

Financial Statements: Credit Allocation in an Era of Non-Banks and New Technologies

In today's session, we had a holistic conversation about credit allocation: the respective roles therein of the public and private sector, banks and markets, the impact of new technologies, and international linkages. The two speakers were Saule Omarova of Cornell Law School, and Vítor Constâncio, former Vice President of the European Central Bank. 

Financial Statements: COVID-19 and the Bank-Sovereign Nexus in Emerging Markets

The speakers in today's session were Tobias Adrian of the International Monetary Fund, and Anna Gelpern of Georgetown Law and PIIE. 

Financial Statements: How Well is European Banking Supervision Working in Practice?

In today's session, I hosted Kilvar Kessler of the Estonian Financial Supervision Authority and Jonathan Zeitlin of the University of Amsterdam. The intent was to assess European banking supervision (also known as the Single Supervisory Mechanism) from the bottom up, complementing the view from the top of that framework in an earlier session of November 2020. 

Ricardo Bofill, December 1939 - January 2022

Ricardo Bofill passed away yesterday in Barcelona. Obituaries are multiplying and generally emphasize his boldness, unique sense of scale and space, and unwillingness to yield to convention or fads. For me he had been a mentor and friend for nearly three decades, since I completed my training at Ecole Polytechnique with a three-months internship at his firm's offices in Barcelona and Paris, in the spring and early summer of 1992.

He subsequently offered to work together on a book of ideas about urban design, which was written in French and published in 1995 (L'Architecture des villes, Odile Jacob publishing). For this I had multiple preparatory discussions with him, at his famed house and offices near Barcelona, at his no less memorable family house in Mont-ras off the Costa Brava, or at the apartment he kept at that time by his firm's Paris office. After the book was done, we did not lose touch and I visited regularly in Barcelona and/or Mont-ras. I have also been in frequent contact with Pablo, his younger son, who was more often in Paris, especially in recent years. 

He had a powerful vision of the importance of architecture and of livable cities, which he expressed first and foremost in his projects but also in numerous writings. A recent synthesis is in the lecture he gave a few months ago when the Polytechnic University of Catalonia (UPC) awarded him an honorary doctoral degree, a kind of reparation gesture (for which the UPC's Félix Solaguren-Beascoa deserves much credit) 64 years after having expelled him as an anti-Francoist student in 1957. I was greatly honored to be invited to participate in a series of pre-recorded tributes delivered during that ceremony, together with Elia Taniguchi, Paolo Portoghesi, and Norman Foster; the video of the event includes Prof. Solaguren-Beascoa's oration, the four tributes, Bofill's acceptance speech, plus assorted pomp and circumstance in Barcelona's extraordinary church of Santa Maria del Mar. 

He has had considerable influence on the way I look at the world, at buildings and landscapes, and at cultures and history. For me, as for many others, he will remain a major inspiration and reference. Even though he is no longer around, his work and ideas live on. 

Financial Statements: Are index funds harmful for global financial stability?

In yesterday's session, I hosted Anusha Chari of UNC Chapel Hill and Alejandro Werner of Georgetown and PIIE, for a discussion based on pioneering research by Chari and her co-authors on the market impact of passive investment strategies. 

Financial Statements: The Nexus of Interest Rates, Banks, and Politics

The session on Wednesday, December 22, explored how far central banks could go into negative interest rates - not a current issue right now, but one that may come back in the medium term. My guests were the IMF's Ruchir Agarwal, and Markus Brunnermeier of Princenton University and PIIE. 

Financial Statements: Lessons Learned on Corporate Credit Risk

In yesterday's session, Sebnem Kalemli-Özcan (University of Maryland) and Atsi Sheth (Moody's) reflected on the benign outcomes so far from the COVID-19 pandemic shock in terms of corporate bankruptcies or zombification. This provided an update on the first-ever Financial Statements session in June 2020, when uncertainty was still very high near the start of the lockdown cycle.