Technology sometimes moves at a dizzying pace. When it comes to innovation in financial activities, often referred to as FinTech, the world is seeing major advances. For banks, FinTech disrupts core financial services and pushes them to innovate to remain relevant. For consumers, it means potentially wider access to better services. Such changes also raise the stakes for regulators and supervisors—while most individual FinTech firms are still small, they can scale up very rapidly across both riskier clients and business segments than traditional lenders. This combination of fast growth and increasing importance of FinTech financial services for the functioning of financial intermediation can come with system-wide risks, which we cover in our latest Global Financial Stability Report. Adding risk Digital banks are growing in systemic importance in their local markets. Also known as neobanks, they are more exposed than their traditional counterparts to risks from consumer lending, which usually has fewer buffers against losses because it tends to be more uncollateralized. Their exposure also extends to higher risk-taking in their securities portfolio, as well as higher liquidity risks (specifically, liquid assets held by neobanks relative to their deposits tend to be lower than what would be held by traditional banks). These factors also create a challenge for regulators: the risk management systems and overall resilience of most neobanks remain untested in an economic downturn. Not only do FinTech firms take on more risks themselves, they also exert pressure on long-established industry rivals. Look for instance at the United States, where FinTech mortgage originators follow an aggressive growth strategy in periods when home lending is expanding, such as during the pandemic. Competitive pressure from FinTech firms significantly hurt profitability of traditional banks, and this trend is set to continue.  Another technological innovation, which has grown rapidly in the past two years, is decentralized finance, a crypto-based financial network without a central intermediary. Also known as DeFi, it offers the potential of delivering more innovative, inclusive, and transparent financial services thanks to greater efficiency and accessibility. However, DeFi also involves the buildup of leverage, and is particularly vulnerable to market, liquidity, and cyber risks. Cyberattacks, which can be severe for traditional banks, are often lethal for these platforms, stealing financial assets and undermining user trust. The lack of deposit insurance in DeFi adds to the perception of all deposits being at risk. Historically, large customer withdrawals often follow news of cyberattacks on providers.  DeFi activities mainly occur in crypto-asset markets, but growing adoption by institutional investors has strengthened the links to traditional financial institutions. In some economies, DeFi is helping to accelerate cryptoization, in which residents embrace crypto assets instead of the local currency. Stepped-up regulation As more financial-services activity moves from regulated banks to entities and platforms with little or no oversight, so do the associated risks. Despite FinTech stepping in to challenge traditional banks on their own playing field, they bring more than competition. In fact, the two often remain intertwined, including through the provision of liquidity and leverage by banks to FinTechs. These pose challenges for financial authorities in the form of regulatory arbitrage (in which firms move or set up operations in less-regulated sectors and regions) and interconnectedness that may require supervisory and regulatory action, including better consumer and investor protection. Policies that target both FinTech firms and traditional banks proportionately are needed. This way, the opportunities that FinTech offers are fostered, while risks are contained. For neobanks, this means stronger capital, liquidity, and risk-management requirements commensurate with their risks. For incumbent banks and other established entities, prudential supervision may need greater focus on the health of less technologically advanced banks, as their existing business models may be less sustainable over the long term. The absence of governing entities mean DeFi is a challenge for effective regulation and supervision. Here, regulation should focus on the entities that are accelerating the rapid growth of DeFi, such as stablecoin issuers and centralized crypto exchanges. Supervisory authorities should also encourage robust governance, including industry codes and self-regulatory organizations. These entities could provide an effective conduit for regulatory oversight. (IMAGE: ANYABERKUT/ISTOCK BY GETTY IMAGES) | Technology, globalization, and global warming have changed the world, and taxation must keep pace. With a mouse click, individuals can move money across borders and corporations can transact with their affiliates across global supply chains. Production depends on intangible know-how assets that can be located anywhere. Employers and their employees can work in different countries. As income and factors of production become more mobile, and with climate change threatening our planet, countries face tax challenges that know no national borders. Tax evasion and avoidance cause the loss of revenue that could have financed social spending or infrastructure investments. They also exacerbate inequality and perceptions of unfairness. Self-serving national policies of one country can affect others in damaging ways. If each sets its own tax policy without regard for the adverse effects elsewhere, all countries can end up worse off. Our new Fiscal Monitor shows how better international coordination in three areas—taxing large corporations, sharing information on offshore holdings, and enacting fair carbon pricing—can benefit everyone. Coordinating on corporate taxation Widespread dissatisfaction with low tax payments by the world’s major multinationals (despite annual profits of 9 percent of global gross domestic product) spurred a groundbreaking agreement to modernize the existing and century-old international system. In 2021, 137 countries reached a breakthrough on coordination: the Two Pillars Solution under the Inclusive Framework. With 2022 set to be a crucial year for implementing the agreement—the object of live political debate in several countries—the Fiscal Monitor gauges its potential benefits. Pillar 1 of the agreement says that a portion of multinationals’ profits must be taxed where the firms’ goods or services are used or consumed. This means that tech companies can be taxed where their customers are located, even if their employees are far from their customer base. In a world where digital commerce is now commonplace, this is a welcome development. While our report finds that the agreed reallocation of tax revenue covers only 2 percent of global profit of multinationals, this new taxation principle sets the stage for a more efficient tax than unilateral digital services taxes. Pillar 2 establishes a global minimum corporate tax of 15 percent. By doing so, it puts a floor on competition, reducing incentives for countries to compete using their tax rates and for firms to shift profits across borders. Some nations will top up their tax on “undertaxed” profit to the minimum level, increasing corporate tax revenues by up to 6 percent globally. By reversing the downward trend of income corporate income tax rates, reduced tax competition could raise revenue by another 8 percent, bringing the total effect to 14 percent. Work should continue, however, to better adapt to low-income countries’ circumstances—for example, to simplify some aspects of corporate taxation, strengthen withholding taxes on cross-border payments, and share more country-by-country information on multinationals. For low-income economies to reap the benefits of recent changes, they need to adopt complementary reforms, such as removing wasteful tax incentives.  Coordinating on personal taxation Much like corporations, the taxation of individuals (especially the wealthiest) also requires coordination across borders. Recent leaks of documents such as the Panama Papers and Paradise Papers revealed a massive stock of offshore wealth and widespread tax loopholes. And with the rise of digital assets that allow for even greater anonymity, the sharing of information is becoming more and more vital. Beyond the revenue loss, opaque offshore accounts designed to hide wealth facilitate the transnational transfer of corrupt proceeds. Coordination can deliver tangible results, and 163 countries have agreed to exchange information under the Global Forum on Transparency and Exchange of Information for Tax Purposes. Yet, more can be done to improve the reliability of the information, our report notes. Countries should do more to promote beneficial ownership registries—information about who really owns or controls a company. Some countries have already established such mechanisms. But how they are implemented matters—information from the registries should be centralized in a public database. Effective use of the information remains critical for enforcement and low-income countries will need to develop more know-how to realize the benefits from transparency. Another recent phenomenon that calls for greater coordination is the increasing mobility of the labor force. Opportunities for cross-border remote work have expanded, along with the number of economies offering digital-nomad visas targeted at high-skilled individuals. Estimates suggest that cross-border remote work—given existing differences in tax rates across countries—reallocates personal income tax revenue between countries by 1.25 percent of global personal income tax revenue. Coordination will gain importance in the future to ensure a consistent tax treatment between countries where employers and employees reside. Coordinating on carbon pricing Concrete coordinated action is even more urgent to fight climate change, because the rapid increase in greenhouse gas emissions is causing us to speed toward disastrous global warming of more than double the limit that scientists consider tolerably safe. An international carbon price floor is analogous to a global minimum corporate tax. But here a few key emitting countries can speed up coordination and make an important start. Such a floor would discourage emissions and alleviate competitiveness concerns. It would limit global warming to 2 degrees Celsius or less while accommodating alternative approaches (such as regulation, through the calculation of equivalent prices). An international carbon price floor could also allow differentiated responsibilities for nations depending on the income level.  As governments grapple with an acceleration of energy prices caused by the war in Ukraine, they should support people (ideally through targeted transfers or lump-sum utility bill discounts) rather than subsidizing fossil fuel consumption. And near-term responses should not detract from efforts to invest in renewable energy and greater energy efficiency. Countries that have already set a gradual rising path for carbon taxation should stay the course—the envisaged increases are far smaller than recent gyrations in prices, which stem from global shocks. Revenues should be used to ensure that all workers and communities benefit from the green transition. At the international level, agreeing on a carbon price floor (or equivalent measures) remains urgent. History tells us that the value of collaboration is even greater as we counteract the economic consequences of pandemics or conflicts. In the same cooperative spirit of scientists working together across borders to fight COVID-19, now is the time to better tax corporations, fight tax evasion, and act for a greener and fairer world.
(PHOTO: STOCKVISUAL/ISTOCK BY GETTY IMAGES) | The demand and supply shocks unleashed by the pandemic were expected to lead to a dramatic collapse in trade, but international commerce has proven more resilient than during previous global crises. While goods trade fell sharply in the second quarter of 2020, it bounced back to pre-pandemic levels later in the year. The decline for services in 2020 (such as tourism) was worse, and has recovered more slowly, given persistent restrictions to contain infection in some countries. International spillovers Factors specific to the pandemic help explain these trade patterns. First, goods imports were larger in 2020 than would be predicted by demand (and relative prices) alone, more so in countries with stringent lockdowns or severe outbreaks. Second, lockdowns had significant—if unintended—international spillovers. Countries with trade partners that implemented more stringent lockdowns experienced larger declines in imports of goods. Trade partner lockdowns accounted, on average, for up to 60 percent of the decline in imports in the first half of 2020. These impacts were larger in industries that rely heavily on global value chains, and are further downstream in the production process (such as electronics).  The effects were short-lived, however, suggesting that global supply chains were resilient. And remote work also lessened the trade spillovers from lockdowns. Even so, disruptions wrought by the pandemic led to calls for more domestic production of goods (reshoring). Our latest World Economic Outlook shows that dismantling global value chains is not the answer—more diversification, not less, improves resilience. Global value chains adapted Trade data affirm this. By mid-2020, Asian countries, which were hit early by COVID-19 but then managed to contain it (just when many European countries imposed severe mobility restrictions) saw an increase in their market share of GVC-related products of 4.6 percentage points in Europe, and 2.3 percentage points in North America. These gains were large and quick by historical standards but as countries adjusted to the pandemic, they’ve partially unwound, suggesting that the changes were likely temporary.  Though global value chains have adjusted, some industries such as automobiles have faced large supply disruptions, pointing to the need to enhance resilience. We analyze two options for building supply chain resilience: diversifying inputs across countries, and greater substitutability of inputs. Boosting trade resilience We simulated the effects of disruptions in a global economic model and compared outcomes under higher levels of diversification, or higher substitutability (how easily a producer can switch inputs from a supplier in one country to another). We considered two scenarios: supply disruption in a single, large, input supplier country; and supply shocks to multiple nations. Our analysis shows that diversification significantly reduces global economic losses in response to supply disruptions. Following a sizable (25 percent) labor supply contraction in a single, large global supplier, gross domestic product for the average economy falls by 0.8 percent under the baseline. In the high-diversification scenario, this decline is reduced by almost half. Higher diversification also reduces volatility when multiple countries are hit by supply shocks. We estimate that the volatility of economic growth in the average country is reduced by around 5 percent in this scenario. Diversification offers little protection, however, when a major disruption hits all economies at the same time, like the first four months of the pandemic. Countries can diversify by sourcing more intermediate inputs from abroad. Currently there is a significant “home bias” in the sourcing of such supplies. Firms in the Western Hemisphere, for example, source 82 percent of their intermediates domestically. Re-shoring of production would thus lower diversification further. Substitutability can be achieved in two ways: through greater flexibility in production, such as when electric vehicle maker Tesla Inc. rewrote software to enable its cars to use alternative semiconductors in response to the semiconductor shortage; or by standardizing inputs internationally. For example, General Motors Co. recently announced that it is working with semiconductor suppliers to reduce the number of unique chips that it uses by 95 percent, down to just three families of microcontrollers. This standardization would replace a host of chips, eliminating the costs of substituting between them. Considering again the scenario of a 25 percent labor supply contraction in a large global supplier of intermediate inputs, we find that with greater substitutability, GDP losses in all countries (other than the source country) are reduced by about four-fifths. Policy implications Ensuring equitable access to vaccines and treatments remains the first policy priority. Recent targeted lockdowns in China are a reminder that pandemic-related restrictions continue to have an impact far beyond the affected country. It is in the self-interest of all countries, including those with high vaccination rates to end the acute phase of the pandemic everywhere. Amid rising concerns regarding global economic fragmentation and “friendshoring” following the war in Ukraine, our analysis also shows that greater diversification and substitutability in inputs can enhance resilience. While corporate decisions will predominantly shape the future resilience of global value chains, government policies can help by providing a supportive environment and lowering the costs. One obvious area is improved infrastructure. The pandemic has shown that infrastructure investments in certain areas are critical to mitigate supply disruptions related to trade logistics. For example, upgrading and modernizing port infrastructure on key global shipping routes would help reduce global chokepoints. Better digital infrastructure to facilitate telework can also help mitigate spillovers to other countries. Governments can also help to make information more widely available, so firms can make more strategic decisions. For example, automobile manufacturers on average conduct business directly with about 250 Tier1 suppliers, but this number rises to 18,000 suppliers in the full value chain. Improving access to information on inter-firm transactions and supply chain networks, by for example, digitalizing firms’ document filings, such as tax returns, can be helpful, especially for smaller firms with fewer resources. Finally, reducing trade costs can help diversify inputs. There is room to reduce non-tariff barriers, which would give a significant medium-term economic boost, especially in emerging markets and low-income developing countries. In addition, reducing trade policy uncertainty, and providing an open and stable, rules-based trade policy regime, can support greater diversification. — This blog, based on Chapter 4 of the April 2022 World Economic Outlook, “Global Trade and Value Chains During the Pandemic,” includes research by Galen Sher and Ting Lan, under the guidance of Shekhar Aiyar, and support from Shan Chen, Bryan Zou, Youyou Huang, and Ilse Peirtsegaele. The analysis was concluded in early 2022, prior to Russia’s invasion of Ukraine, and does not focus on the implications of the war for global trade and value chains.
(IMAGE: IMF) | We live in dangerous times. The world faces renewed uncertainty, as war comes on top of an ever-changing and persistent pandemic, now in its third year. Moreover, problems that predated COVID-19 have not gone away. When policymakers return to Washington in the coming days for the Spring Meetings of the IMF and World Bank, one of the central topics will be growing debt vulnerabilities in the world. Debt was already very high before the first coronavirus lockdowns. As the pandemic hit, unprecedented peacetime economic support stabilized financial markets and gradually eased liquidity and credit conditions around the world. In many countries, fiscal policy was able to protect people and firms during the pandemic. It supported monetary policy, too, by adding to aggregate demand and avoiding deflationary dynamics. It all contributed to financial and economic recovery. Now the war in Ukraine is adding risks to unprecedented levels of public borrowing while the pandemic is still straining many government budgets. The situation highlights the urgent need for authorities to undertake reforms, including governance reforms, to improve debt transparency and strengthen debt management policies and frameworks to reduce risks. The Fund will continue to help address the root causes of unsafe debt with granular policy advice and capacity-building activities. But, with elevated sovereign debt risks and notable budget and financial constraints, international cooperation to minimize stress during the period ahead will be needed. In cases where liquidity support alone is not enough policymakers need to take a cooperative approach to ease the debt burdens of the most vulnerable countries, foster greater debt sustainability, and balance the interests of debtors and creditors. Record debt During the pandemic, deficits increased and debt accumulated much faster than they did in the early years of other recessions, including the largest: the Great Depression and the Global Financial Crisis. The scale is comparable only to the two 20th century world wars. According to the IMF’s Global Debt Database, borrowing jumped by 28 percentage points to 256 percent of gross domestic product in 2020. Government accounted for about half of this increase, with the remainder from non-financial corporations and households. Public debt now represents close to 40 percent of the global total, the most in almost six decades.  Emerging market and developing countries (excluding China) accounted for a relatively small share of the increase. Although their public debt remains far below 1990s levels, debt in these economies has risen steadily in recent years. This partly reflected their ability to tap private markets, increased creditworthiness, and development of their domestic debt markets. Servicing costs have also been on a steep incline. About 60 percent of low-income countries are now in, or at risk of, distress. Risks from rising inflation Until recently, low debt service costs assuaged concerns about advanced economies’ record high public debt. There were two elements. First, nominal interest rates were very low. In fact, they were close to zero or even negative all along the yield curve in countries such as Germany, Japan and Switzerland. Second, neutral real interest rates were on a significant downward trend in many economies, including the United States, the euro area, and Japan, as well as a number of emerging markets. This, combined with real interest rates below real growth rates, contributed to a perception of painless fiscal expansion. However, with heightened risk perception and expected monetary policy tightening, debt vulnerabilities are back in focus. High public and private borrowing contribute to financial vulnerabilities, which are already concerning. The number of advanced economies with debt ratios larger than the size of their economy has increased significantly. There is a risk that ever-higher levels of debt lead to a widening of interest rate spreads for countries with weaker fundamentals, making it costlier for them to borrow. Moreover, although inflation surprises may lower debt-to-GDP ratios in the short-run, persistent inflation—and inflation volatility—ultimately can raise the cost of borrowing. This process can happen quickly in countries with short debt maturities. In advanced economies, economic activity, the primary balance, spending, and revenues are projected to return close to pre-pandemic projections by 2024. But the situation in developing countries is much more concerning. Both emerging and low-income economies face persistent GDP and revenue losses. This implies that primary spending will be persistently lower as a consequence of the pandemic, pushing countries further back from reaching the Sustainable Development Goals. That is a matter of global concern. Sharp increases in energy and food prices are adding to these pressures for the poorest and most vulnerable. Food accounts for up to 60 percent of household consumption in low-income countries. These countries face a unique confluence of factors: dire humanitarian needs intersect with extremely tight financial constraints. For low-income countries that rely on imported fuel and food, the shock may require more grants and highly concessional financing to make ends meet while supporting those households in need. Global financial conditions are tightening as major central banks raise interest rates to contain inflation. In most emerging markets, sovereign spreads are already above pre-pandemic levels. The credit crunch is exacerbated by declining overseas lending originating from China, which is confronting solvency concerns in the real-estate sector; expanding lockdowns in Shanghai and other major cities; the transition to a new growth model; and problems associated with existing loans to developing countries. A global cooperative approach Debt restructurings are likely to become more frequent and will need to address more complex coordination challenges than in the past owing to increased diversity in the creditor landscape. Having mechanisms in place for orderly restructuring is in the best interest of creditors and debtors alike. For low-income countries, the Debt Service Suspension Initiative expired at the end of 2021. And the Group of Twenty’s Common Framework for Debt Treatments beyond the DSSI has yet to deliver. Improvements are needed. Options should also be explored to help the broader range of emerging and developing economies that are not eligible for the Common Framework but who would likely benefit from a globally cooperative approach in the period ahead. Muddling through will amplify costs and risks to debtors, creditors and, more broadly, global stability and prosperity. In the end, the impact will be most sharply felt by those households that can least afford it. With sovereign debt risks elevated and financial constraints back at the center of policy concerns, a global cooperative approach is necessary to reach an orderly resolution of debt problems and prevent unnecessary defaults. The views and interests of debtors and creditors must be reflected in a balanced way. |
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