Economy

The writer is senior research fellow on China in the Asia-Pacific Programme, Chatham HouseWhen President Xi Jinping came to power in 2012, his vision was for China to become a leader of the Global South. His Belt and Road Initiative, launched in 2013, and the Global Development Initiative, which Xi announced at the UN General Assembly in September last year, are tools for projecting Chinese influence in the developing world. Whether the GDI succeeds will serve as a test of China’s economic statecraft. The keyword in Beijing’s description of the initiative is sustainability, with the emphasis less on physical infrastructure projects, and more on poverty alleviation and sustainable development through grants and capacity-building, all with the stamp of approval of the UN’s 2030 Sustainable Development Goals.The GDI has attracted less criticism thus far in the west than its older sibling, the colossal BRI with its reputation for opacity and a lack of financial sustainability. Nevertheless, it displays many of the distinctive characteristics of past grand Chinese initiatives. It is fluid in nature, opaque in implementation and flexible in the measures used to deliver projects and offer grants. This has long been the preferred style of Chinese political elites. Former Chinese leader Deng Xiaoping described his ethos for reform in the late 1970s as “crossing the river by feeling the stones”.Xi has adopted the same approach with the GDI. Deng used this tactic for the domestic economy at a time when China was isolated in the aftermath of the Cultural Revolution. But Xi needs the involvement of many countries to achieve his vision, just as Beijing’s global relationships are becoming more fraught in the wake of the Russian invasion of Ukraine and a tense military and diplomatic stand-off over Taiwan.Another issue is foreign assumptions about the nature of one-party rule in China and the belief that policy is immaculately planned and executed from the upper echelons of Xi’s team. This may lead to unrealistic expectations among the developing countries participating in the GDI. In fact, the initiative requires laborious co-ordination between various ministries, agencies and state-owned banks in Beijing. China has already realised that aspects of its international development programmes are no longer as popular as they were — partly because some of these projects carry serious risks for participating countries without proper due diligence. In the case of the GDI, China should focus on producing a clear and concrete action plan tailored to specific regions and themes. This would enhance the scheme’s clarity and financial credibility.But the eventual success of the GDI is not only dependent on China’s money and capability. It also relies upon the co-operation of around 60 countries that are already part of a GDI “Group of Friends” established within the UN in January 2022. For many countries in this group, the ravages of the Covid-19 pandemic have exacerbated problems with already fragile social welfare networks. These states, many of them extremely vulnerable, crave meaningful assistance rather than diplomatic bromides.In the past two decades, China has poured hundreds of billions of dollars into building physical infrastructure across the developing world. Meanwhile, many of the countries involved have pinned their hopes on China, as well as the advanced economies, continuing to finance poverty alleviation programmes and public health provision.But Beijing’s spending spree must come to an end as it grapples with its own economic woes. This presents China with a dilemma: can it tighten its belt while also maintaining close relations with developing countries? Beijing has sought to solicit their support in the multilateral institutions, notably on issues related to Taiwan.The ultimate test of Beijing’s economic statecraft is whether it can engage with developing countries beyond relationships built on financial resources and diplomatic capital. Showering cash on these places is not always guaranteed to win hearts and minds. China must show that it understands what such economies really want from their interactions with it and what they fear, based on their experiences of past initiatives. Beijing should avoid the mistakes it made with the BRI, and instead focus on high-quality project delivery and bringing real benefits to participating countries. This requires more than merely forming a Group of Friends, which promises much but risks delivering little.Are we heading towards a global recession? Our economics editor Chris Giles and US economics editor Colby Smith discussed this and how different countries are likely to react in our latest IG Live. Watch it here. More

A strike that has covered parts of Edinburgh with rubbish and tarnished the return of the Scottish capital’s international festival of culture, is set to spread to 13 other local authorities after council leaders and unions failed to reach a wage agreement.Unison, the UK’s biggest public services union, said on Wednesday it would have accepted the 5 per cent uplift offered by the government were it not for the cost of living crisis, which has added to the financial strain on Scottish workers. Citigroup this week said UK inflation could peak at more than 18 per cent next year, as European gas prices set a new record.The escalation of industrial action in Scotland is the latest in a wave of walkouts across the UK as workers battle for higher wages as living costs continue to rise sharply. “This is a national crisis playing out in Edinburgh’s streets during our busiest and most important time of the year,” said Edinburgh council leader Cammy Day of the opposition Labour party. “We need the Scottish government to get back round the table.”The strike has also fed into pre-existing disputes in Scotland about the funding of local government, which in Edinburgh has attracted attention as international visitors have gathered for the first full return of the Edinburgh festival after two years of Covid-19 restrictions. Speaking at a festival event on Wednesday, Nicola Sturgeon, Scotland’s first minister, said that while she understood workers’ demands during a time of a cost of living crisis and high inflation, her government was constrained to act by the need to balance its budget.“I would love to be able to offer pay rises that were in line with inflation,” she said in response to a question about a pay dispute at NHS Scotland.The build-up of rubbish in premier tourist sites has embarrassed city leaders, while opposition parties criticised the Scottish National party government, saying it had cut funding for local authorities. In turn, the administration in Edinburgh has blamed the government in London for tightening budgets.The other unions involved in the dispute with Cosla, the body representing councils across Scotland that collectively spend £19bn a year and account for close to 10 per cent of jobs, are Unite and GMB. Unison said it had given notice of the walkouts by support staff at schools and nurseries from September 6, while Unite confirmed strikes by bin collectors and other waste services workers would spread to Glasgow and Aberdeen, among other areas.

While the dispute is between councils and unions, the Scottish government had come under increasing pressure to intervene. Unison said John Swinney, deputy first minister, was due to meet union and Cosla representatives later on Wednesday.Unite argued that, for more than half of local government workers in Scotland, the 5 per cent pay offer was inferior to that given to counterparts in England, by between £700 and £1,000. Unison said it had originally asked for a £3,000 flat rate uplift. The Scottish government said it had provided an extra £140mn to help give staff a bigger pay rise, which equated to more than half of what Cosla needed to make the 5 per cent offer.Scotland’s budget deficit was £23.7bn, or 12.3 per cent of gross domestic product, in 2021, according to data released on Wednesday. The Government Expenditure and Revenue Scotland (Gers) report showed that Scotland accounted for 9.2 per cent of total UK public sector expenditure, with £17,793 spent per person — almost £2,000 greater than the UK average. More

Can the Federal Reserve tame the highest inflation in roughly 40 years without causing sharply higher unemployment?Top officials at the US central bank say it can be done — but even they concede a recession cannot entirely be ruled out.History suggests a so-called “soft landing” is a rare outcome.Since the 1950s, the US economy has tipped into a recession within two years every time inflation has exceeded 4 per cent and unemployment has fallen below 5 per cent.The dilemma confronting the Fed today is as extreme as it gets, with inflation running at multi-decade highs and unemployment at multi-decade lows.This combination has created one of the most acute challenges for the central bank in the post-second world war era, testing the credibility of the institution and the fortitude of its leadership, helmed by Jay Powell.Here’s how Alan Blinder, the former vice-chair of the Fed who served in the 1990s, sees it: “They are trying not to slam on the brakes too hard. Will they pull it off? I think it’s difficult and the odds are against them.”The Fed’s primary policy tool is thewhich it adjusts to influence borrowing costs for banks, businesses and households in order to achieve both parts of the central bank’s mandate: stable prices and a healthy labour market.When the Fed wants to cool down a red-hot economy, it raises its benchmark policy rate above asetting, a level that neither restrains nor revs up growth. If the economy is languishing, the Fed will lower the fed funds rate below neutral to boost borrowing, encourage spending and support the labour market.To gauge inflation the Fed looks closely at changes in the core measure of the personal consumption expenditures price index — known as core PCE — which excludes volatile items like food and energy prices.Over time, it seeks to achieve inflation that averagesWhile core measures are good at predicting future inflation, the Fed also keeps close tabs on broader metrics like the consumer price index, which measures price changes paid by consumers for everyday goods and services.This metric is important because it influences people’s expectations about future inflation.The Fed also seeks to foster an environment of low unemployment, where everyone who is willing and able to work has a job.Defined as “maximum employment,” the second goal of the Fed’s dual mandate is to maintain the highest amount of employment that can be sustained without creating excessive inflation.Officials pay close attention to the non-accelerating inflation rate of unemployment NAIRU, which is an estimate of the lowest level of unemployment before unwanted price pressures start to mount.Not all tightening cycles have resulted in aBut the Fed’s track record is spotty at best. Nearly every time the central bank has raised interest rates above neutral to rein in inflation, a recession has followed soon after.What makes the current situation all the more challenging is the enormity of the inflation problem. At no point in the past four decades has the Fed’s preferred inflation gauge run so far above its 2 per cent target and unemployment hovered so far below what is considered a sustainable rate, analysis from Deutsche Bank shows.After first moving cautiously to scale back the massive amount of policy support being pumped into the economy and financial markets, the central bank was forced to abruptly pivot. It is now tightening monetary policy at the most aggressive pace since 1981.In just four months, the Fed has raised the fed funds rate from near-zero to a new target range of 2.25 per cent to 2.50 per cent. To get there, officials implemented supersized rate rises, including two consecutive 0.75 percentage point increases. Typically, the Fed adjusts its benchmark policy rate in quarter-point intervals.Interest rates are expected to continue rising, with another 0.75 percentage point increase under consideration for September’s policy meeting. Rates will need to increase to a level that actively restrains the economy, Fed officials say, but just how restrictive they need to be and for how long remain open questions.The Fed’s goal is to avoid a repeat of the severe economic shock it was forced to deliver in the 1980s in order to get a handle on inflation after a series of policy mistakes in the 1970s.Rather than the “hard” landing that defined that period, the Fed wants to emulate the quintessential soft landing of the early 1990s, when it successfully addressed budding inflationary concerns without causing undue economic pain.The 1970s is a cautionary tale for the Fed and underscores the risks of “stop-go” monetary policy in which the central bank flip-flopped between raising rates to stem inflation and cutting rates to shore up growth. In the process, it failed to vanquish high prices and inflation became deeply embedded into the psyches of Americans.This emblematic episode, which can trace its roots back to the late 1960s, became known as the period of the “Great Inflation”. It gathered momentum in the early part of the decade after Arthur Burns took over as Fed chair in January 1970 amid a recession and unnerving geopolitical shocks.Between 1972 and 1974, the Fed raised interest rates as growth rebounded.It then cut rates in 1975, when the economy had tipped into a recession . . .. . . but before inflation had moderated sufficiently.And though inflation fell from its peak, it settled at a relatively high level.The oil crisis in 1979, which led to nationwide gasoline shortages and soaring prices, ignited yet another round of inflationary pressure and revealed in stark detail the magnitude of the Fed’s policy errors.Paul Volcker sought to change that when he took over as chair in August 1979. By then, inflation had climbed to 12 per cent and was poised to rise further.After two months in the job, Volcker fundamentally changed the way the Fed set monetary policy, targeting the supply of money in the financial system rather than interest rates explicitly. The fed funds rate quickly neared 14 per cent.Over the course of a couple of months, rates skyrocketed further, plunging the economy into a recession.Around that time, Volcker said: “Failure to carry through now in the fight on inflation will only make any subsequent effort more difficult, at much greater risk to the economy.”By the end of 1982, the economy had collapsed and another recession ensued. Unemployment rose sharply as millions of people lost jobs and debt crises rippled across emerging markets.Inflation, meanwhile, fell back to 5 per cent.The Fed was able to ease monetary policy soon after, providing much-needed relief to the labour market.There are big differences between the current situation and the circumstances of the 1970s. The Fed has far more credibility now than in the past and its commitment to keeping prices stable is more deeply ingrained.However, the tumult of that period — and the economic downturn that followed — offers up important lessons for the central bank today: a failure to tighten monetary policy enough now could allow inflation to become entrenched and ultimately require more drastic action later.“It was at least a dozen years of just utter abdication of responsibility and a ratcheting up of inflation,” says Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics and a former Fed staffer.“By the time Paul Volcker came in, everyone expected that inflation was just going to continue indefinitely,” he adds. “That is just not the case now. Everyone is willing to give the Fed the benefit of the doubt.”Powell recently signalled that the central bank had internalised the lessons of the 1970s, saying: “If you fail to deal with [inflation] in the near term, it only raises the cost of dealing with it later.”Still, Fed officials remain steadfast that there is a path to bring down inflation without causing a recession, similar to what was achieved in 1994.Under the leadership of Alan Greenspan, the Fed successfully set monetary policy to stamp out inflationary fears while keeping growth intact.The key to getting it right was pushing back on pressure to raise rates more, says Blinder, Greenspan’s second-in-command at the time. “There was tremendous hawkish sentiment, both inside the [Fed] and out in the markets that the Fed had to go higher, higher, higher, higher, and we resisted that.”In just over 12 months, the Fed doubled interest rates to 6 per cent, cooling down an economy that had boomed in the aftermath of the 1991 recession.Inflation, which had been running at over 3 per cent before the Fed began to raise rates, eased.Unemployment did not spike, hovering at 5 per cent two years later. Growth slowed in 1995 but never contracted.That is the outcome the Fed is trying to pull off today, but Powell has acknowledged the path to do so has “clearly narrowed . . . and may narrow further”. Rather than soft, the landing may be “softish”, he has said.Success will partly depend on factors beyond the Fed’s control, including whether the commodity price surge and supply bottlenecks largely caused by Russia’s invasion of Ukraine and China’s Covid lockdowns abate.The odds of a “softish” landing largely depends on the resilience of the labour market. Unemployment rises even in the mildest of recessions — by roughly 2 percentage points — according to an analysis of the postwar period by Goldman Sachs.But with unemployment hovering at a historically low level of 3.5 per cent and an urgent worker shortage that translates to nearly two vacancies for every unemployed person, today’s job market is one of the tightest on record and, in turn, among the most potentially inflationary.To retain staff and attract new hires, employers have boosted pay and improved benefits — sowing fears of a “wage-price spiral” whereby companies are forced to charge more for their products and services to cover higher costs, leading workers to demand even higher pay to keep pace with rising prices.Fed officials argue that their efforts to cool labour demand will result in employers shrinking the number of job openings as opposed to slashing positions altogether. As of June, most officials projected unemployment to rise to 4.1 per cent in 2024 from its current level of 3.5 per cent.Yet many economists are sceptical that the fight against inflation will play out in such a benign manner, not least because it will require the Fed striking exactly the right balance between tightening too little and too much. Monetary policy also works with a lag, meaning it takes time for the full effects of the Fed’s actions to ripple through the economy.For Donald Kohn, who served as the Fed’s vice-chair during the global financial crisis, the main risk is that unemployment will need to rise much more than is expected in order to take the heat off inflation.“My suspicion is that they are going to have to take rates higher than even they thought, and certainly more than the markets thought,” he says of the Fed.Sectors most sensitive to fluctuations in interest rates, like housing, are already starting to feel the pinch of higher borrowing costs, with sales and prices plummeting. Business investment has already started to moderate and consumers have not been as downbeat since the global financial crisis more than a decade ago. Some economists think the US is already in a recession, given that the economy has contracted for two quarters in a row.While Fed officials appear committed to reducing inflation and maintain there are still clear signs of strength in the economy, they acknowledge the risks posed by squeezing demand excessively. That suggests they may soon recalibrate how aggressively they will raise interest rates going forward.“The next period is going to be a really tough one,” says Bill English, a Yale professor and former director of the Fed’s division of monetary affairs. “They want to take the heat off, but not have the economy go into the ditch, and that’s tricky to manage.”19601970198019902000201020200%5%10%15%20%010203040506070MonthsVisual storytelling team: Sam Learner, Sam Joiner and Caroline NevittSources and notes: Economic data comes from the Federal Reserve (FRED) and the US Bureau of Labor Statistics. Neutral Rate of Interest figures come from the Federal Reserve of New York, and reflect the real interest rate that is “expected to prevail when the economy is at full strength and inflation is stable”. The analysis of past tightening cycles since the 1950s referenced in the introduction was conducted by Alex Domash and Larry Summers, the former Treasury secretary. Historical sums of deviations from maximum employment and inflation come from a Deutsche Bank analysis. More

The Chinese yuan has been dropping against the dollar and market participants said the telephone warnings suggested authorities may be getting uncomfortable with the speed of the slide.Responding to a Reuters request for comment, the State Administration of the Foreign Exchange (SAFE) said it had not seen financial institutions unreasonably buying large amounts of foreign exchange. More

Average transaction prices are set to reach a record $46,259, an 11.5% increase from a year earlier, according to the report from auto industry consultants J.D. Power and LMC Automotive.However, an inventory shortage continues to shackle new vehicle sales. Retail sales of new vehicles are expected to reach 980,400 units in August, a 2.6% decrease from a year earlier, the consultants added.The latest forecast is an indication the U.S. Federal Reserve’s rapid pace of interest rate hikes to tame inflation is yet to have a sizeable impact on the auto industry, which has benefited from consumers’ preference for personal transport during the pandemic.”In September, the constraints are expected to continue with sales being hampered by available inventory. In the near term, prices and per-unit profitability will remain strong,” said Thomas King, president of the data and analytics division at J.D. Power.The consultants do not expect provisions from the Inflation Reduction Act for a tax credit boost to “materially influence” electric vehicle (EV) sales volume in the near term due to limited EV availability.August seasonally adjusted annualized rate (SAAR) for total new vehicle sales is expected to be 13.3 million units, up 0.2 million units from 2021, the report showed.J.D. Power and LMC Automotive also bumped their 2022 global light-vehicle sales forecast by nearly 1 million units to 81.8 million due to a resurgent China market, which is expected to have an 8% growth in sales compared with last year. More

China will add 19 new policies on top of the existing steps unveiled in May, including raising the quota on policy financing tools by 300 billion yuan ($43.69 billion), state media cited the cabinet as saying after a regular meeting chaired by Premier Li Keqiang.The country would make good use of carryover special bond quotas of 500 billion yuan and would support centrally owned power generations firms to issue 200 billion yuan in bonds, the cabinet was quoted as saying.”Currently, the economy continues the recovery trend in June, but the foundation of recovery is not solid,” the cabinet was quoted as saying.Authorities will take “timely and decisive measures, maintain a reasonable policy scale and make good use of policy tools in the toolkit, and intensify efforts to consolidate the foundation for economic recovery,” the cabinet added.The cabinet, while reiterating that China will avoid excessive stimulus, has sent officials to provinces to check the implementation of the policy steps, state media said.China will reduce funding costs and will approve a batch of infrastructure projects, the cabinet was quoted as saying.On Monday, China cut its benchmark lending rate and lowered the mortgage reference by a bigger margin, as Beijing boosts efforts to revive an economy hobbled by a property crisis and a resurgence of COVID-19 cases.China will unveil policies to support private firms and the platform economy which includes tech companies, it said.It will allow localities to use city-based credit policies to reasonably support rigid housing demand, it said.China has allocated 10 billion yuan in funds to support rice production amid drought, and will issue 10 billon yuan in subsidies for farm materials, the cabinet said.China’s economy narrowly escaped a contraction in the June quarter. Economic activity rebounded in June but slowed in July, raising pressure on policymakers to step up support.In May, the cabinet announced a package of 33 measures covering fiscal, financial, investment and industrial policies to revive the COVID-ravaged economy.Authorities have given policy banks 800 billion yuan in new credit quotas to fund infrastructure projects, and allowed policy banks to issue 300 billion yuan in bonds to help some key projects meet the minimum capital requirement.($1 = 6.8666 Chinese yuan) More

Ethiopia requested debt relief from its creditor governments in early 2021 under a new G20 framework for debt restructurings, but progress has been complicated by a 21-month civil war that began in the northern Tigray region.Ethiopia’s creditor committee, which is co-chaired by representatives of the Chinese and French governments, first met only in September 2021.In a statement issued on Wednesday, the creditor committee said that members had discussed the latest macroeconomic developments at its most recent meeting on July 19.”The creditor committee for Ethiopia will pursue its work to find an appropriate solution to external debt vulnerabilities of Ethiopia, in a timely, orderly and coordinated manner,” the committee said.The committee said it welcomed talks in June between the government and International Monetary Fund staff and looked forward to further discussions about an IMF support programme, which is necessary for debt relief.An IMF mission to the country is due next month to follow up on the June visit, a senior advisor to the country’s finance ministry said on Tuesday.The IMF, the World Bank and others are pushing China, Ethiopia’s biggest creditor, and private creditors to accelerate work on debt treatments sought by Ethiopia, Chad and Zambia under the G20 joint debt restructuring framework.Ethiopia’s finance ministry said in a statement it appreciated the IMF’s engagement and that it had shared all the relevant data about its debt stock and its strategy for managing its debt over the long term in four meetings with the creditor committee.”The Government of Ethiopia thanks the Creditor Committee for their commitment and looks forward to an expeditious conclusion of the debt treatment discussion,” it added. More

UK imports of goods from Russia have collapsed to a record low as a result of economic sanctions over the war in Ukraine, according to official data. Imports of goods from Russia totalled £33mn in June, down 96 per cent year on year and the lowest since comparable data was first published in 1997, the Office for National Statistics said on Wednesday.For the first time on record, there were no imports of fuel from Russia. UK goods exports to Russia also fell 67 per cent compared with the monthly average of the year to February 2022.The data come as Russia’s invasion of Ukraine and the decision to cut gas supplies in retaliation for sanctions exacerbate the cost of living crisis by driving up soaring household energy and food costs.“The war in Ukraine has resulted in a collapse in the UK’s trade flows with Russia,” said Ruth Gregory, senior UK economist at Capital Economics, a consultancy.She added that the war’s far bigger effect on the British economy was “via the worsening in the UK’s terms of trade caused by the surge in energy and food prices, which has significantly eroded household and corporate incomes”.Wednesday’s figures were in stark contrast to the overall UK trend: goods imports and exports rose by an annual rate of about 35 per cent in June. ONS data showed that imports from other oil-producing countries, such as Norway and Qatar, soared compared with the monthly average of the year to February 2022, compensating for the lack of Russian energy imports. US goods imports from Russia also collapsed by an annual rate of 76 per cent in June, while EU imports from the country were up 43 per cent. This reflects continuing imports of Russian gas, on which the bloc is heavily dependent. Exports to Russia from both the US and the EU fell sharply because of sanctions. The ONS figures showed UK exports of most commodities to Russia had fallen substantially in June, with machinery and transport equipment contracting 91 per cent, or £118mn, over the same period. UK exports of cars to Russia have ceased completely.

One exception was UK exports of medicinal and pharmaceutical products, which are unaffected by the sanctions for humanitarian reasons. They jumped 62 per cent in June compared with the prewar period.More than 96 per cent of goods imported from Russia are subject to restrictions, as well as 60 per cent of goods exported to the country. Goods subject to export bans include those that can be used for both civilian and military purposes, and aviation and space-related equipment. There is also an export ban on machinery. But the ONS said it was “likely that some traders are ‘self-sanctioning’”, meaning that traders are being cautious in dealing with Russian groups.Following this week’s rise in the benchmark European gas price to a record high of €292.50 per megawatt hour, asset manager PGIM Fixed Income on Wednesday revised down its forecast for the UK economy to an annual 0.1 contraction for next year from a 0.8 per cent expansion. “The economy’s momentum fell sharply in Q2, and the costly pass-through of energy prices to consumers is expected to weigh heavily on consumption,” said Katharine Neiss, chief European economist at PGIM Fixed Income. More