What We're Reading:

What We're Reading:

France sends Germany gas for first time amid Russia energy crisis. Though the new flow is less than 2% of Germany's daily needs, it is welcome as Berlin battles to diversify its energy. (BBC)

Despite turmoil, UK Treasury chief says economic plan stays. Britain’s Treasury chief on Thursday rejected suggestions that the Conservative government would reverse course on economic plans that have roiled financial markets even after Prime Minister Liz Truss faced widespread criticism from her own lawmakers during a closed-door meeting. (AP)

China’s Xi gets chance to tighten hold on economy at meeting. President Xi Jinping, China’s most influential figure in decades, gets a chance to install more allies who share his vision of an even more dominant role in the economy for the ruling Communist Party and tighter control over entrepreneurs at a party meeting that starts this weekend. (Business Mirror)

Vladimir Putin proposes ‘gas hub’ plan to Turkey's Erdogan. Russian President Vladimir Putin has put forward Turkey as a potential hub for Russian gas to third parties, including Europe, with a new pipeline. (DW)

6 new climate tax credits that benefit manufacturers. This summer, the Inflation Reduction Act (IRA) was signed into law, opening $370 billion of investment into initiatives to fight climate change and boost domestic manufacturing. (IndustryWeek)

UNCTAD calls for tighter commodity market regulation to combat inflation. Commodity market speculation should be more stringently regulated to halt abrupt changes in food and energy prices, a report by the UN Conference on Trade and Development (UNCTAD) has suggested. (Global Trade Review)

UN demands Russia reverse ‘illegal’ annexations in Ukraine. The UN General Assembly voted overwhelmingly Wednesday to condemn Russia’s “attempted illegal annexation” of four Ukrainian regions and demand its immediate reversal, a sign of strong global opposition to the seven-month war and Moscow’s attempt to grab its neighbor’s territory. (Business Mirror)

Saudis say US sought 1 month delay of OPEC+ production cuts. Saudi Arabia said Thursday that the U.S. had urged it to postpone a decision by OPEC and its allies—including Russia—to cut oil production by a month. Such a delay could have helped reduce the risk of a spike in gas prices ahead of the U.S. midterm elections next month. (AP)

Is the small business surge in the US sustainable? The number of new business applications jumped 24% in 2020, then another 23% last year. And while filings have come down this year, they remain elevated compared to levels before the pandemic. (BBC)

China's major party congress is set to grant Xi Jinping a 3rd term. And that's not all. Xi Jinping, China's top leader, is widely expected to secure another five-year term as party boss and commander-in-chief of the military. How the rest of the chips fall remains to be seen, and could offer hints about Xi's power and priorities. (NPR)

The pandemic could have changed how employers think about layoffs. Although that may seem dim, economists say there is reason to believe that some employers could be more hesitant than in the past to lay off workers in a potential economic downturn. (Vox)

Putin offers Europe gas through Nord Stream 2, Germany declines. Russian President Vladimir Putin offered to resume gas supplies to Europe through the intact part of the Nord Stream 2 gas pipeline. (DW)

Hot inflation report sends dollar to 30-year high versus yen. Thursday’s hot inflation report has strengthened the U.S. dollar and pushed it to levels last seen decades ago against the Japanese yen. (Barron’s)

Germany’s recent announcement of a 200-billion-euro national plan to shield its citizens and economy from spiraling energy costs was a bombshell for its European partners.

As a result, at last weekend’s informal European summit in Prague, the most powerful EU country was accused of taking an egoistic, going-it-alone approach and had to contend with more unfamiliar charges of financial recklessness. In the eyes of Germany’s critics, nobody in the EU could match Berlin’s fiscal largesse. Hence, other EU economies risked being put at a competitive disadvantage.

At stake, no less than the survival of the hallowed common market. Whenever EU politicians resort to that kind of rhetoric, it usually means things risk getting seriously bad.

Price Caps or No Price Caps?

The informal summit provided a chance to vent frustration, but did not produce a breakthrough on the contentious question of whether the EU needs to introduce price caps on gas. The idea had been first tabled by outgoing Italian Prime Minister Mario Draghi.

Until Prague, a handful of partners, led by Germany, and including the EU commission, stubbornly opposed price caps for fear of upsetting energy markets and jeopardizing energy supplies as a result. However, the clumsy handling of Berlin’s 200-billion euro energy plan changed the dynamic of the discussion, as it appears to have significantly eroded Germany’s negotiating clout on the matter.

Pushed by a growing number of member states, the EU Commission now accepts that the array of common measures introduced so far, such as reducing energy consumption or filling gas storage facilities, falls short of what is needed to tackle the twin challenge of reducing gas prices and ensuring adequate levels of supplies in the medium term.

The president of the EU Commission, Ursula von der Leyen, now promises far-reaching concrete legislative proposals in time for the next formal summit at the end of October, importantly, including ways of introducing price caps for gas.

None of the various ideas Europe is currently examining seems to be free of potential serious drawbacks, which explains why agreeing on a plan has proven to be so elusive. At the same time, avoiding difficult decisions risks making a painful recession in the bloc more likely, as excessively high energy prices continue to fuel inflation and weaken households and firms.

At the time of writing, the specifics of the commission’s proposal are still unclear. Options include negotiating prices with reliable suppliers as a bloc, limits on the influence of gas on electricity and a dynamic, flexible cap on prices. The former measures would likely have a medium- to long-term impact; the latter should have a more immediate effect on energy prices. There is also talk of setting up a common financial support mechanism.

Risks of Going It Alone

The handling of the challenge so far offers a few broader lessons for Europe and Germany. One is that an emphasis on national decisions risks playing into Vladimir Putin’s hands, undermining much of what the EU has achieved so far in its response to the Russian aggression in Ukraine. If going it alone energy policies are the norm, one extreme step member states could be tempted to take eventually is to try making separate arrangements with Moscow.

Governments expected to hold the line against angry voters who fear a cold winter more than Russian boots on Ukrainian soil need to be able to offer alleviating measures in return. Many EU members are exhausting their fiscal capacity to do so. One notable example is Italy, where the incoming national conservative coalition of Giorgia Meloni has promised to stay firm against Russia, despite grumblings within its own ranks and amongst voters.

A failure to find effective common answers at the EU level would no doubt fire up anti-Brussels and anti-Germany rhetoric in Rome and elsewhere.

Another lesson is that wasting precious time rarely pays off. Germany is trying to stave off the energy crisis with a huge debt financed fiscal shield, when other partners who intervened earlier, such as France, managed to contain energy prices more effectively at a much lower cost. The negative reaction from EU partners to the German plan caught Berlin off guard.

Following Same Pattern as Pandemic

What is true at a national level is even more relevant in the EU context. Only a few weeks ago, EU officials complimented each other on the speed with which they managed to forge decisions on the energy crisis. However, speeding up the cumbersome decision-making process proved to be insufficient, as common measures primarily focused on low-hanging fruit. And the bulk of the difficult steps needed to address high prices and supply security were left to member states with various degrees of financial and negotiating capabilities.

Some of the more reluctant EU leaders should by now have realized that contrary to what they have professed so far, this crisis is following the same pattern of the pandemic emergency, or in earlier days, the financial crisis. Having tested national solutions first, national governments realize that they not only fail to achieve the results hoped for, but more importantly, risk jeopardizing European unity. Of course, waiting before acting decisively together has another unintended consequence: It makes the price tag for common interventions higher.

Reprinted with permission; Brink News

Korea’s economic recovery from COVID-19 is well anchored, driven by consumption, employment and export growth and with less direct exposure than some other economies to risks from Russia’s war of aggression in Ukraine, according to a new OECD report.

The latest OECD Economic Survey of Korea says that following its skillful management of the pandemic, Korea should now turn to long-standing challenges and focus on structural reforms to address population ageing, raising youth employment, closing gaps in social protection and fostering business dynamism.

With a rapidly aging population underscoring the need for fiscal consolidation, plans to adopt a new, more stringent, fiscal rule are welcome, the Survey says. Korea should also start to phase out support that keeps unproductive small and medium-sized firms alive. That, along with streamlining regulations, could help to boost competition and reduce productivity gaps between large and small companies that drive discrepancies in living standards.

Korea saw one of the smallest GDP contractions among OECD countries in 2020, followed by a strong export-led rebound in 2021 and early 2022. Employment has surpassed pre-crisis levels and high demand for Korean goods means GDP growth is set to continue, albeit at a slower pace given the pressures on global growth. The Survey sees GDP growth at 2.8% in 2022 and 2.3% in 2023, with inflation subsiding back to below 4% in 2023 after peaking at 6.3% in July 2022 as the war in Ukraine raised inflationary pressures globally.

Korea has limited trade and financial linkages with Ukraine and Russia and has sizable quantities of oil and gas in storage. However, a dependence on the two countries for raw materials such as rare gases used to produce semiconductors has highlighted the need for resilience and diversification in the sourcing of key inputs for industry. Greening electricity production can boost resilience of energy supply and is needed to reach ambitious emission targets.

Closing gaps in job security and social protection should also be a priority in a country where only half of the labor force currently has access to unemployment benefits. This can be attained by relaxing employment protection for regular workers and expanding employment insurance and social protection for non-regular workers. Korea’s tax and benefit system could also be improved to boost work incentives, especially for low-income workers. Addressing these challenges would facilitate youth employment, reduce gender gaps, boost earnings for older workers and underpin long-term growth.

Financial conditions have tightened as central banks continue to hike interest rates. Amid the highly uncertain global environment risks to financial stability have increased substantially.

Major issues facing financial systems include inflation at multi-decade highs, continuing deterioration of the economic outlooks in many regions, and persistent geopolitical risks, as we discuss in our latest Global Financial Stability Report.

To avoid inflationary pressures from becoming entrenched, central banks confronting stubbornly high inflation have had to accelerate monetary policy tightening. What’s more, those in advanced and emerging economies alike also face magnified risks and vulnerabilities across different sectors and regions.

Financial vulnerabilities are elevated for governments, many with mounting debt, as well as nonbank financial institutions such as insurers, pension funds, hedge funds and mutual funds. Rising rates have added to stresses for entities with stretched balance sheets.

At the same time, the ease and speed with which assets can be traded at a given price has deteriorated across some key asset classes due to volatile interest rates and asset prices. This poor market liquidity, together with pre-existing vulnerabilities, could amplify any rapid, disorderly repricing of risk, were it to occur in the coming months.

Global markets are showing strains as investors have recently become more risk-averse amid heightened economic and policy uncertainty. Financial asset prices have fallen as monetary policy has tightened, the economic outlook has deteriorated, recession fears have grown, borrowing in hard currency has become more expensive, and stress in some nonbank financial institutions has accelerated. Bond yields are rising broadly across credit ratings, with borrowing costs for many countries and companies already rising to the highest levels in a decade or more.

Property concerns

The faltering property sector in many countries raises concerns about risks that could broaden and spill over into banks and the macroeconomy. Risks to housing markets are growing because of rising mortgage rates and tightening lending standards, with many more potential borrowers now being squeezed out of markets. Stretched housing valuations could adjust sharply in some market segments.

Emerging markets are confronting a multitude of risks, including high external borrowing costs, stubbornly high inflation and volatile commodity markets. They also face heightened uncertainty about the global economy, and policy tightening in advanced economies.

Strains are particularly severe in frontier markets—generally smaller developing economies—where challenges are driven by a combination of tightening financial conditions, deteriorating fundamentals and high exposure to commodity price volatility.

Investors have so far continued to differentiate across emerging economies. While many frontier markets are at risk of sovereign default, many of the largest emerging markets are more resilient to external vulnerabilities to date. Having said that, after the stabilization of outflows in the first half of the year, foreign investors are again pulling back.

Emerging and frontier market bond issuance in U.S. dollars and other major currencies has slowed to the weakest pace since 2015. Without improved access to foreign funding, many frontier market issuers will have to seek alternative sources and/or debt reprofiling and restructurings.

The global banking sector has been bolstered by high levels of capital and ample liquidity buffers. However, the IMF’s Global Bank Stress Test warns these buffers may not be enough for some banks. In the event a sharp tightening of financial conditions causes a global recession next year amid high inflation, 29 percent of emerging-market banks (by assets) would breach capital requirements. Most banks in advanced economies would fare much better, the stress test indicates.

The challenging macroeconomic environment is also putting pressure on the global corporate sector. Credit spreads have widened substantially, and high costs are eroding corporate profits. For small firms, bankruptcies have already started to increase because of higher borrowing costs and diminished fiscal support.

Policy recommendations

Central banks must act resolutely to bring inflation back to target and avoid a de-anchoring of inflation expectations, which would damage their credibility. Clear communication about policy decisions, commitment to price stability, and the need for further tightening will be crucial to preserve credibility and avoid market volatility.

Exchange rate flexibility helps countries adjust to the differential pace of monetary policy tightening across countries. In cases where exchange rate movements impede the central bank’s monetary transmission mechanism and/or generate broader financial stability risks, foreign exchange intervention can be deployed. Such interventions should be part of an integrated approach to addressing vulnerabilities as laid out in the IMF’s Integrated Policy Framework.

Emerging and frontier markets should reduce debt risk through early engagement with creditors, multilateral cooperation and international support. For those in distress, bilateral and private sector creditors should coordinate on preemptive restructuring to avoid costly defaults and prolonged loss of market access. Where applicable, the Group of Twenty Common Framework should be used.

Policymakers face an unusually challenging financial stability environment. Though no globally systemic event has materialized so far, they should contain further buildup of vulnerabilities by adjusting selected macroprudential tools to tackle any pockets of risk. In this highly uncertain environment, striking a balance between containing these potential threats and avoiding a disorderly tightening of financial conditions will be critical.

This blog is based on Chapter 1 of the October 2022 Global Financial Stability Report, “Financial Stability in the New High-Inflation Environment.”

Reprinted with permission by IMF Blog.

Week in Review Editorial Team:

Annacaroline Caruso, editor in chief

Jamilex Gotay, editorial associate

Kendall Payton, editorial associate