With interest rates and inflation skyrocketing, servicing debt has suddenly become a top concern for investors, public-sector bankers, and central banks. Looking at factors such as government and household finances, which are the most indebted countries? You might be surprised.

According to data published by London-based investment fintech Invezz, Japan, Greece, Italy, Portugal, and the US are the top five nations with the highest level of government debt.

Japan’s national debt is a whopping 236% of GDP, the highest percentage of all developed countries, according to Invezz’s research, which is based on OECD data. Japan’s public debt grew rapidly during the coronavirus pandemic driven by a significant increase in emergency spending while its debt-to-GDP ratio grew because GDP growth declined. The Bank of Japan is the buyer of most domestic bonds; these securities allow the government of Japan to access finance at an ultra-low interest rate which experts point to as the main reason why the country has been able to sustain such high debt levels.

With a debt-to-GDP ratio of 185%, most of Greece’s national debt problems appear to stem from the post-2008 global financial crisis (GFC) period, which sparked one of the worst economic collapses since the Great Depression. Greece, alongside countries such as Portugal, Spain and Italy, were most impacted by the fallout from the GFC as they struggled to refinance government debt and bail out struggling banks because they had the biggest debt burdens in Europe before the crisis began.

“Regional factors may be a large part of why Italy’s debts are so high at 134.1%,” states Invezz. Italy was one of the EU countries hit hardest by Covid-19 and–like many governments–stepped up government borrowing during the pandemic to finance emergency spending. According to Fitch Ratings, Italy’s gross general government debt-to-GDP ratio will remain high until 2025, as economic growth is expected to slow faster than falls in the budget deficit.

The United States of America ranks fifth, with its approximate government debt at a staggering $22.7 trillion or 108% of GDP, according to the OECD data used by Invezz. However, June 2022 data published by the US put debt at more than 126% of the country’s nominal GDP, with most of the increased spending due to the Covid-19 pandemic. 

The UK—which faces a ‘profound’ economic crisis, according to its new prime minister, in large part because of debts it racked up during the pandemic and higher borrowing costs—had the 10th highest debt-to-GDP ratio, according to Invezz’s research, at 83.9%. If former Prime Minister Liz Truss’s mini-budget, which featured £45 billion of unfunded tax cuts, had been implemented, the UK’s general government debt would have jumped to 109% of GDP by 2024 according to Fitch Ratings, reflecting both higher budget deficits and a weaker growth outlook.

But just focusing on government debt-to-GDP ratios doesn’t tell the whole story, according to Invezz’s research.

By aggregating credit-card ownership, household debt as a percentage of disposable income, and the number of Google searches for debt and credit-related terms per 100,000 people into a metric, Invezz created its list of countries with the biggest debt burdens.

With an overall Invezz debt score of 8.42 out of 10, Canada came out as the country on top with the highest debt followed by the UK in second spot with a score of 7.92 and the US in third place with a score of 7.75 out of 10.

“Canada appeared in the top 10 countries for each factor we looked at while also topping the table for credit card ownership,” said Invezz. At 83%, Canada has the highest level of credit-card ownership, ahead of Japan and Switzerland with 69%.

The UK has the most debt-curious population, according to Invezz, with 2,385 Google searches for several debt and credit-related terms per 100,000 people, putting it ahead of the US with 1,446 searches per 100,000 and Australia with 1,166 searches. It also made the top 10 for government debt and for credit-card ownership, for which it placed seventh.

The US placed in the top 10 for debt and credit-related searches, national debt, and credit-card ownership.

Norway is the country with the highest level of household debt based on OECD data followed by Denmark and the Netherlands. With household debt at more than 246% of net disposable income in Norway, people owe almost two and a half times the amount of money they have available for general household expenditures, Invezz’s research revealed. Denmark is not far behind Norway, with household debt as a percentage of net disposable income at 244%, and the Netherlands at 228%.

After a tumultuous 44 days in office—which saw unprecedented interventions by the Bank of England in the gilts market, and sterling falling to a 35-year low against the dollar—Liz Truss has resigned as UK Prime Minister.

But she won’t be forgotten quickly. During her short-lived tenure as PM, Truss and her Chancellor Kwasi Kwarteng’s £45 billion of unfunded tax cuts announced in September’s mini-budget sent UK bond markets into a downward spiral, triggering the Bank of England to act and avert a financial crisis as yields on long-dated UK government bonds plummeted.  

“Although Truss was brought into usher in an era of growth and ‘trickle-down economics’, her strong pro-growth policy was poorly timed, as her policies fanned the flames of surging inflation,” said Giles Coughlan, Chief Market Analyst at HYCM commenting on Truss’ resignation.

Coughlan says Truss’ departure is likely to be mildly GBP positive, depending on her successor for the premiership. “Already, the UK gilt market was supported,” he said, “as rumors of the prime minister’s resignation came to light this morning, which is a good sign for the pound’s stability.”

But Truss’ resignation ushers in yet another round of turmoil in UK politics in as many months. In the last four months alone, the UK has had four chancellors, three home secretaries and two prime ministers.

Having shown her chancellor, Kwarteng, the door, following the market’s disastrous reaction to their mini-budget, his successor, Jeremy Hunt, tried to restore financial markets’ confidence in the trajectory of UK fiscal policy earlier in the week by unwinding most of the tax cuts they announced back in September. But now much of Hunt’s efforts could be undone by the ongoing political instability.  

Nigel Green, CEO of deVere Group, an independent financial advisory, asset management and fintech firm, said Truss’ resignation will fuel financial-market fears as political chaos in the UK heightens.

“Markets are unforgiving. We have seen this in recent weeks when the pound hit historic lows against the dollar, gilt yields jumped, and stock markets dipped due to reckless economic policies set out by the Truss government,” he said. “Investors know that the political chaos that has defined the UK throughout 2022 is nowhere near over, and this fuels uncertainty and drives turbulence in financial markets.”

Noting that inflation has hit more than 10% and the country has no functioning government,  “to investors, the UK looks ungovernable,” Green added, “and its economy resembles that of an emerging market, not a G7 nation.”

The pound was up almost 1% against the dollar and almost half a percent against the euro, following news of the resignation. But the relief will be shortlived as political uncertainty remains.

“The pound, gilt markets, amongst others, will remain under pressure for the foreseeable future,” said Green.

The scrapping of most of Truss’ economic agenda in a bid to calm markets is seen by many as a loss of credibility, which cannot be regained all that rapidly. “U-turns and abandoning landmark economic policy after economic policy does not inspire investor confidence and trust,” noted Green, who added that UK financial assets remain hugely unattractive for investors right now and markets will reflect this.

While many will be glad to see the back of “Trussenomics,” William Marsters, Senior UK Sales Trader at Saxo, said the announcement of a Tory leadership contest next week leads to more uncertainty on who could be next in No. 10.

“Sterling’s game of Snakes-and-Ladders is far from over, yet it’s unlikely GBP will show many signs of long-term recovery,” said Marsters, who predicts citizens are likely to continue to suffer from rising inflation.

But it’s not just inflation the UK is battling. There are other risks, unique to the UK, including its proximity to the Ukraine crisis, geopolitical instability, and Brexit, says HYCM’s Coughlin . “If I was a multinational thinking about where I would like to develop my office and I had a strategic interest in Europe,” he wonders, “would I be thinking of the UK—where you don’t know what corporation tax is going to be from one moment to the next?” Businesses stability and predictability for at least a medium-term outlook but “we don’t know what’s going on with the UK,” Coughlin says. “The UK doesn’t know what’s going on with itself.”

On September 19, millions of Brits paid their last respects to Her Majesty Queen Elizabeth II who was laid to rest at Windsor Castle. For many, they weren’t only mourning the passing of their long-reigning sovereign, but also the end of an era closely linked to the country’s colonial past.

During her 70-year reign, Queen Elizabeth II made frequent trips to Commonwealth countries, many former colonies. But the number of Commonwealth countries or realms the Queen presided over as head of state dwindled from 32 at the start of her reign to just 15 at the time of her death: including Jamaica, the Bahamas, Grenada, Papua New Guinea, the Solomon Islands, Tuvalu, Saint Lucia, Saint Vincent & the Grenadines, Belize, Antigua & Barbuda, and Saint Kitts & Nevis. Some former colonies declared independence, while others—like Fiji, Mauritius, and Barbados—became republics.

The broader 56-member Commonwealth group promotes economic and trade interests. While its roots lie in the former British empire, many of its members are republics already independent of the monarchy. 

But for the 15 countries that remain parliamentary monarchies, the Queen’s passing may present an opportunity to shrug off colonial pasts. During an official visit by the former Duke and Duchess of Cambridge in March, Jamaica’s Prime Minister Andrew Holness put the monarchy on notice that the island would seek independence.

Other countries may follow. “Queen Elizabeth II’s death marks a watershed moment for the future of the Commonwealth, with a variety of member nations in Africa, Asia, and the Caribbean asking whether the time has now come to not only bid farewell to Queen Elizabeth II, but to the British Royal Family as a whole,” the Organization for World Peace wrote in a September 19 blog post. In the same post, Malaysian politician Lee Boon Chye says his country should reconsider its membership in the Commonwealth, alluding to its colonial legacy.

Recently, the pound has plunged to levels not seen against the dollar since the mid-1980s, following the announcement of £45 billion in unfunded tax cuts by the UK government. At one point, sterling hit a 35-year low of 1.03 against the dollar.

“The currency has fallen close to 10% on a trade-weighted basis in a little under two months,” ING economic analysts wrote on September 26. “That’s a lot for a major reserve currency.”

Giles Coghlan, the chief currency analyst at London-based brokerage HYCM, says the recent sell-off in sterling is a sign that markets are undecided about the size of the announced tax cuts, how indiscriminate they are and the risk they pose to inflation. They come when most central banks, including the Bank of England, are looking to reduce inflation by hiking interest rates.

On September 28, the Bank of England, which had earlier announced plans to scale back its purchases of UK debt, was forced to temporarily intervene in the gilts market with time-limited purchases to prevent prices of long-dated UK gilts from spiraling out of control and avert a financial crisis.

Many also anticipated an emergency interest rate hike from the bank. The central bank’s chief economist, Huw Pill, said it would comprehensively assess the macroeconomic and monetary situation ahead of its next meeting in early November before deciding on monetary policy.

But hiking interest rates by 150 bps wouldn’t have made much of a difference, according to Coughlan. “The pound [was] falling because of a loss of confidence. This is now going to have to play out in the political sphere.”

George Hulene, assistant professor in finance at Coventry University’s School of Economics, Finance and Accounting, says the UK government now needs to do something substantial to reassure financial markets how it is going to plug the £45 billion gap its tax cuts have left in the public finances. Prime Minister Lizz Truss and Chancellor of the Exchequer Kwasi Kwarteng have yet to reveal details of how they will fund their significant tax cuts.

“For the current sell-off in sterling to stop, the government has to show what actions it is putting in place to remove the indiscriminatory aspects of their fiscal policy and how the economy will not be hit by unfunded tax cuts,” says Hulene.

If these details aren’t forthcoming, it is likely to be another massive blow to the pound, which had regained some of the ground it had lost over the last few days, ending the day’s trading at $1.1 on September 29, he adds. However, Hulene notes that sterling’s problems began long before Kwarteng announced the tax cuts.

No Short-Term Answers

In 2014, the pound was up almost 1.7 against the dollar. But immediately after the Brexit referendum result in 2016, the reserve currency experienced its biggest fall within a day in 30 years, reaching as low as $1.34 at one point.

There were two further substantial and sustained falls in 2017 and 2019, which saw the pound record new lows against the euro and the dollar, according to the UK economics think tank, the Economics Observatory.

More recently, other factors — the UK’s proximity to the war in Ukraine, continued deadlock with the EU regarding Brexit and the Northern Ireland Protocol agreement and a strengthening dollar, which has been gaining since the US Federal Reserve started hiking interest rates in March — have also weighed on the pound, say experts.

The best-case scenario for sterling would be peace in Ukraine, a resolution to the Brexit Northern Ireland Protocol impasse with the EU, and falling inflation in the US, which could spell the end of the Fed’s rate-hiking cycle, according to HYCM’s Coghlan. 

Nonetheless, stronger than expected US economic data published on September 29, which saw personal consumption figures being printed at 2% versus the expected 1.5%, is likely to give US Fed Chairman Jerome Powell little excuse to hold back on further rate rises, said William Marsters, a senior sales trader at Saxo UK.

The war in Ukraine has also ramped up with Russia’s annexation of Ukraine’s Donetsk, Luhansk, Kherson and Zaporizhia regions, and the EU hopes that the UK’s current financial woes could lift the ‘deadlock’ on the Northern Ireland Protocol.

Meanwhile, concerns are growing about how the current volatility in sterling and FX markets could impact CFOs’ balance sheets.

The hit to corporate earnings from the current escalation of FX volatility, particularly in sterling, could reach more than $50 billion in impacts on earnings by the end of the third quarter, according to Wolfgang Koester, a senior strategist at Kyriba, which publishes a quarterly Currency Impact Report based on earnings reports for publicly traded North American and European companies. These losses stem from these companies’ inability to monitor and manage their FX exposures accurately. “Companies with a major FX hit are likely to see their enterprise’s value, or earnings per share, go down,” he says.

“Central bank governors in this country have never been popular,” says Ásgeir Jónsson, governor since August 2019 of Seðlabanki Íslands, Iceland’s central bank, and the only central banker in this year’s Report Cards to be awarded an A+.   

The small island, nestled between Scandinavia and North America, has endured its fair share of economic shocks, which has forced the Sedlabanki to take drastic and unpopular actions in the past.

The 2008-2011 financial shock triggered a collapse in Iceland’s economy, three of its biggest privately owned commercial banks and its currency, the krona. Inflation soared from below 4% in late 2007 to 18% in early 2009.

The Sedlabanki responded by drastically hiking the effective policy rate, which peaked at 18% in early 2009 before falling back down to 5.5%. It is a period in Iceland’s economic history that Icelanders and Jónsson, who was then chief economist and head of research at Kaupthing Bank (later Arion Bank), won’t forget any time soon.

With the 2008 economic meltdown and high inflation from that period still fresh in its mind, in May 2021, Iceland’s central bank became the first in the West to start tightening monetary policy, following steep rate cuts during the pandemic. The bank’s key policy rate increased by two percentage points to 2.75%, bringing it back to pre-pandemic levels.  

Global Finance: What prompted you to start hiking rates in May last year, when other central banks held off as they thought inflation was “transitory”?

Ásgeir Jónsson: The high inflation of the 1980s, 1990s and the 2008 financial shock when the economy collapsed is still within the living memory of most Icelanders. We are a small, open economy and really do not believe in transitory inflationary shocks, as the consequence of delayed action is much more severe than in the larger economies, given how rapidly small systems can destabilize through excessive credit creation, financial inflows and currency market volatility.

Our experience has taught us to be vigilant in keeping the economy stable and inflation within bounds, as the cost of mistakes is very large. In the spring of 2021, we saw all the usual signs on the wall of rising cost pressures, especially from abroad. Also, the labor market recovered quite rapidly. It was a sharp recovery.

GF: Why do you think other Western central banks did not believe inflation was a real problem sooner?

Jónsson: There are two reasons why central banks underestimated inflation. They overestimated how slowly aggregate supply would recover after Covid, especially in the face of the changed composition of the demand. Second, given that they endured very long periods of depressed inflation, they overlooked the signs very early on of increased cost pressures. They were a little complacent. However, given that we import all our durable goods, we were keenly aware of the broken supply chains and rising international prices. German factories started to raise prices very rapidly. At the same time, the price of our merchandize exports rose, thus there was a great expansion in our foreign sector with both imports and exports expanding very rapidly, which is always the harbinger of an economic expansion and inflation.

GF: How much debate was there within the central bank’s Monetary Policy Committee about hiking interest rates so soon?

Jónsson: There wasn’t that much debate. The committee was unanimous, although at that point there were still concerns about the impact of new strains of Covid-19. However, our decision to raise rates immediately met with harsh criticism in the media. People were saying that we were paranoid, unprofessional. They kept looking at big central banks like the Fed or the European Central Bank saying, “They think inflation is transitory. You are just Icelandic hillbillies.”

Unlike the rest of Europe, Iceland never got into quantitative easing or negative interest rates. Given our demographics and economic fundamentals, our natural rate of interest has been much higher than that of Europe, and thus a zero lower bound on nominal rates was never a problem. It is of course natural that we face the question from the public, the business sector and labor unions on why we could not have zero or negative policy rates like they had in Europe. What we always tried to point out is that Iceland is a very fast-growing economy, which is why the real interest rate is much higher than in Europe. [At the central bank’s last meeting In August, the key interest rate was raised by 0.75% to 5.5%, one of the highest rates in Western Europe.]

Let’s put this into perspective. The median age of Iceland’s population is 35. Our birth rate is high. We import a lot of labor from Eastern Europe. We have abundant natural resources and sources of renewable energy. All this translates into fast growth and demand for both labor and capital and relatively tight monetary policy.

So, we were quite pleased when we started to see our approach adopted by other central banks. Given our relationship to the United States—Iceland’s economy is 1,000 times smaller than the US’s—it was important for us to see the Fed embark on an aggressive hiking cycle. It is the only central bank that has the power to quell international inflation. Having been criticized for our approach, for me it was a relief. Also, given that Iceland is a price taker on international markets, we are bound to import inflation from abroad should it persist. Thus, we need to see action from the larger central banks.

With other countries raising interest rates, it also meant we were less likely to attract “hot” money from hedge funds looking for higher yields. It was important for us to not see Iceland standing out of line in terms of nominal interest rate levels.

GF: So, more than 12 months on, how does the media and Icelanders perceive the central bank’s actions?

Jónsson: Our approach has created a lot of pain for the public, but I think that in general there is a greater understanding and belief in what we are trying to achieve. We are seeing the [positive] effects from our policy. After the war in Ukraine started, we saw an acceleration in inflation. We took an aggressive approach and introduced three steep hikes [75 basis points to 100 bps] in rates in a row. We were afraid that inflation expectations would become de-anchored, so we responded accordingly.

The last inflation numbers were comforting. Inflation is falling. Looking at the harmonized price index, we have the lowest inflation in Europe behind Switzerland. [The Harmonised Index of Consumer Prices in June 2022 was 9.6% in the EU and 8.2% in Germany, whereas the price increase was 7.0% in Norway, 5.4% in Iceland and 3.2% in Switzerland.] That is because of the early action we took. Our forecast that inflation would peak at 11% later this year now looks overly pessimistic. We hope that inflation has peaked.

One other reason for our aggressive approach was the pending general wage negotiations with the labor unions. There is a history of unions gathering in one place to negotiate three-year wage contracts in an economywide setting. One of the main reasons we decided we had to act quickly and decisively was to give unions a signal that inflation was going down next year, so when they sit down to make these new wage agreements they will not factor in inflation.

GF: Do you anticipate further rate hikes before the end of the year?

Jónsson: We are now seeing the signs of early rate hikes having an effect. Since we acted so early and decisively, we hope that we can afford to take smaller steps soon. The Monetary Policy Committee is meeting again in early October. We’ll see. We are now waiting for verifiable signs that our actions are having an impact. We want to see inflation continue to go down.

During Covid-19, Icelanders accumulated large amounts savings. But this summer, they went all out and started spending a great deal of money. Hotels were fully booked by tourists. Summer saw a huge increase in revenue. Our currency did not depreciate due to domestic consumption. What will happen moving forward? Will people quieten down now they’ve been able to spend their savings, or will it continue?

I think Icelanders understand it is important to keep control of the economy. The consequences for a small economy to lose control of inflation can be quite devastating.

GF: You’ve stated that the future of monetary policy lies in the expansion of the policy toolbox. Other than interest rates, what are those other tools in the toolbox?

Jónsson: Four to five months after I became governor of the central bank in 2019, we merged the central bank and the Financial Supervisory Authority (FSA). What we have been trying to prevent is for a boom in the real economy to translate into a financial boom. The new legislation gave us a sweeping mandate to put in place tighter controls on lending. We have imposed capital adequacy ratios exceeding 20%, which are much higher than the rest of Europe. We’ve not only been aggressive in hiking rates, but also in trying to contain a boom in lending by applying borrower-based measures limiting leverage and burden of payment.

In a small, open economy, we must watch out for deposit creation, which increases money supply and impacts the currency market. Our FSA mandate is just another tool that helps us keep control of lending and deposit creation. We also have huge FX reserves, which we can used to maintain stability in our balance of payments. Iceland is one of the smallest currency areas in the world with independent monetary policy, and we must look to every tool in our box to maintain sovereign control of our markets and economic system. That is the challenge of being small. You must act quickly, but at the same being small means that you can get quick rewards.

Central bank digital currencies, or CBDCs, are “a [slow moving] train leaving a station,” Frantz Teissèdre, head of Interbank Relationships at Societe Generale, once said. “We don’t know where it’s heading, but we want to be on board.”

According to the latest data from the Atlantic Council’s CBDC Tracker, more than 100 countries—representing more than 95% of global GDP—have boarded the CBDC train. That’s up from just 35 countries in May 2020. It’s the central bank equivalent of a modern day goldrush, with central banks lining up to mint digital coins, or at least test the prospect of what that would entail.

Yet, only 10 countries have fully launched actual CBDCs into circulation. Among those countries are China, which is set to expand its digital yuan pilot in 2023; Jamaica, which launched the JAM-DEX in July this year; and Nigeria, which launched its CBDC last October.

In the US, the Federal Reserve Board of Governors is currently exploring what CBDCs could mean for corporates and the public at large. And, in July 2021, the European Central Bank initiated a two-year project to study the potential of a digital euro for retail payments.

“Realistically, widespread adoption of CBDCs is still a number of years away given how few banks are actually issuing it,” says Andy Schmidt, global banking lead at IT and business consulting firm CGI. “Three to five years is the timeline that many central banks are working with currently.”

While it may seem that all central banks have decided to launch their own digital currency, only a relatively small percentage are actively running tests, Paul Beecham, payment innovation lead and crypto expert at Societe Generale, explains. The others are just trying to discourage private competitors from undermining their monetary sovereignty.

The Lessons of Libra

Beecham is referring to the failed Libra project, which was rebranded as Diem and led by Meta Platforms. The company tried to launch a global stablecoin back in 2019, when it was still doing business as Facebook. Libra met with substantial resistance from lawmakers and central banks, largely due to the threat it posed to central bank monetary sovereignty.

Libra may have been kicked into the long grass for now, but it did spur central banks into action, with retail CBDC projects such as Sweden’s e-krona and the digital euro gathering pace. Their goal, as BNP Paribas digital solutions manager Matthieu Deraedt explains, is to ensure that individuals operating in an increasingly digitalized economy still have access to the safest form of money—central bank money—and avoid currency substitution.

As for corporate treasury departments, do they benefit from CBDCs? For treasurers, the main transformation of a retail CBDC, Deraedt argues, would be a change of format. “CBDC being ‘settlement money,’ compared to other retail payments options like debit cards or non-instant domestic payments, the money would arrive faster on the treasurer’s account and probably at a cheaper cost,” he says. 

Once CBDCs are deployed successfully at the domestic level, Deraedt believes the next topic for central banks is CBDC’s role as a vehicle for cross-border transactions. “There we see potential benefits for international treasuries,” he adds.

A full-scale multi-central bank digital currency (mCBDC) network that facilitates round-the-clock, cross-border payments in real time could potentially save global corporates up to $100 billion in transaction costs annually, according to a joint report from J.P. Morgan and management consulting firm Oliver Wyman.

Of the nearly $24 trillion in wholesale payments that is moved across borders every year, global companies incur billions in total transaction costs, the firms stated. That excludes potential hidden costs in the form of trapped liquidity and delayed settlements. CBDCs could potentially solve a lot of these headaches for treasurers.

“The good news for large corporates transferring significant cash within or outside the company is that [a CBDC] would allow them to monitor the funds transfer in real-time and at any moment, reducing the time and money spent on resolving incidents,” says Beecham.

In economies with less well-established banking networks, CBDCs could be used to validate the transaction histories and identities of organizations, thus facilitating trade from companies in those countries, Schmidt says.

Relying on peer-to-peer systems with fewer intermediaries, CBDCs also bring speed. “Funds are transferred instantly through a high-speed, blockchain-powered corridor directly from the payer to the payee,” explains Beecham. That 24/7/365 availability could also be a game changer, as payment systems’ reduced opening times are a big negative for treasurers.

“Lastly, all this simplification of processes may result in cheaper payments and cash management,” he says.

What treasurer wouldn’t welcome that? Fraud in international CBDC payments could also be a thing of the past, says Bob Stark, global head of Market Strategy at Kyriba, given the prospect of very strong controls and fraud prevention inherent in the system.

“The capacity of the system to deliver digitized security and virtually zero risk is an attribute and quality of this new potential value system that corporates, and even individuals, will not overlook,” he says.

But CBDCs are described as “a slow-moving train” for a reason. Realizing their full potential both domestically and cross border, and for multiple currencies, presents a mind-boggling array of challenges and questions—many of which remain unanswered at this stage.

Since the functional and technical designs for different CBDCs are unclear, and there are likely to be differences in design choices and distribution models between countries, Deraedt anticipates it will be difficult for treasurers to apply the same rules to all CBDCs.

“For example, it seems that the US and UK are concluding that blockchain is not the best solution when it comes to a population-scale cash alternative and would prefer an account-based system,” he says. “Whereas other locations, like China or potentially Europe, may use blockchain.”

For treasurers, these choices will impact CBDCs: how they function, their interoperability and the tools to manage them. “End-user experience might also be hampered by an insufficient degree of interoperability,” says Deraedt.

When it comes to the impact CBDCs have on treasury workflows, Beecham says many questions remain unanswered. Will corporates have deposit limits? Will those deposits bear interest or not? Will CBDCs be managed centrally by central banks or distributed in another way? What technology (distributed ledgers or something else) will be used? Will it be interoperable with other payment methods and other digital currencies? Will the CBDC be usable offline?

Most central banks have yet to decide whether distribution will be indirect (banks are involved, the same as today), direct (the central bank holds the accounts and handles KYC), or hybrid (the central bank holds the accounts but commercial banks deal with KYC), Beecham says.

However, central banks are reluctant to bypass commercial banks, as this may cause bank runs that would make banks’ funding position weaker. “Also, if central banks were to open accounts to the whole population and/or decide directly, the deposit rate, their legitimacy and independence could be questioned. So, the main challenge for central banks today is finding the right balance,” Beecham explains.

Anticipating Change

Stark of Kyriba says it will be important for corporate financial professionals to understand the changes that could impact financial services industry partners. An interest-bearing CBDC, for example, could shift lending away from traditional financial institutions.

At this stage, it is difficult to imagine that CBDCs would mean corporates hold deposits directly at the central bank, Deraedt says. However, they could use intermediaries other than commercial banks to access CBDCs. “Why not telcos, for example?” he adds.

Public-Private Balance

One of the key challenges for the development of CBDCs, observes Sean Devaney, director of Strategy for Banking and Financial Markets at CGI, is to balance the need to facilitate lending in the commercial bank sector, against the growth of deposits in CBDCs at the central bank.

“The structure of the CBDCs and the facilities that they offer will drive much of this behavior,” he explains. “However, it is likely that financing will still be sourced from commercial banks, so there will need to be an ongoing relationship between treasurers and their bank.”

Where there is likely to be variation, he says, is in some of the international transfer and cash-sweeping activities, where the likely more efficient, cross-border processing of CBDCs could have a more significant impact on revenue that large commercial banks have come to rely on.

Even if there are no reasons to doubt the commitment of central banks to prepare for CBDC issuance, there is still considerable work ahead if the CBDC gold rush is to result in not just tests or pilots, but more CBDCs in circulation. Nevertheless, Daerdt says corporate treasurers should know that CBDCs will become a reality within two to five years, at least in some geographies and with China at the forefront.

Now is the time to build business cases to assess the long-term impacts and value a digitalization of payments, liquidity, working capital and risk management transformations could deliver, says Stark.

“Our customers, and the market in general, are seeing an acceleration in the adoption of digital technologies across all market segments and industries in response to geopolitical uncertainty, FX volatility and unstable financial markets,” Stark adds. “Potential for a highly secure, safe, and real-time digital currency backed by the Federal Reserve offers very strong business value.”

With the collapse of stablecoins like Terra’s Luna, and the lack of regulatory clarity regarding crypto asset investors’ rights and level of protection, the European Council presidency and the European Parliament reached an agreement regarding the EU’s Markets in Crypto-Assets (MiCA) regulation on June 30, which couldn’t come soon enough for many.

Although national legislation for crypto assets already existed in some member states, no specific regulatory framework at the EU level has existed until now.

“[This] agreement heralds a new dawn for the cryptocurrency industry, providing regulators with the tools to stamp down on potential money laundering and other illicit activities that have plagued the crypto market in recent years,” says Gerald Hessenberger, managing principal at Capco, a global technology and management consultancy. 

Under the MiCA, crypto-asset service providers (CASPs) will be required to protect consumers’ crypto wallets or face liability if they lose investors’ crypto-assets. The European Securities and Markets Authority also will be granted powers to ban or restrict CASPs that fail to protect consumers’ and investors’ interests or threaten market stability.

For stablecoin issuers, the new regulation requires them to have a sufficiently liquid reserve, with a 1:1 ratio and partly in the form of deposits. “Every so-called ‘stablecoin’ holder will be offered a claim at any time and free of charge by the issuer,” the EU Council stated in a June 30 prepared statement.

To prevent the use of crypto assets for money laundering, newly updated Transfer of Funds rules were also provisionally agreed upon by the European Parliament and Council on June 29 to include the previously uncovered product class of crypto assets. Hessenberger says the update extends the obligation of payment service providers to accompany funds transfers with information on the payer and payee of crypto assets.

While this will be viewed as a positive step by financial institutions, Hessenberger notes that the financial burden on CASPs and the end of anonymity in even small-sized crypto transactions could cause an exodus from the EU to other regions such as Singapore, Japan or South Korea. “However, the regulation is something CASPs will ultimately have to embrace and prepare for,” he adds.

Has the crypto Wild West finally been tamed? The EU, at least, hopes so with its new MiCA regulation, which other regions may now seek to emulate.

On June 27, Russia defaulted on its foreign debt for the first time since 1918. “Holders of Russia’s sovereign debt had not received coupon payments on two eurobonds worth $100 million [combined] by the time the 30-calendar-day grace period expired, which we consider an event of default under our definition,” said ratings agency Moody’s in an issuer comment.

The default is thought to affect mostly Western bondholders, with so-called friendly or neutral countries such as China and India unlikely to care that much about the default, in terms of their willingness to continue working with Russia, according to Gerard DiPippo, a senior fellow in the Economics Program at the Center for Strategic and International Studies in Washington, DC.

However, Moscow argues that it’s not really in default, as it tried to make the repayment on the coupons but the funds it transferred got stuck at Euroclear Bank. Due to EU sanctions on Russia’s National Settlement Depository because of the war in Ukraine, the Russians attempted to use Euroclear instead.

According to the June 27 comment from Moody’s, “The failure of these payments to reach bondholders follows the expiry of the general license of the US Office of Foreign Assets Control on May 25, which, until then, had allowed US financial institutions involved in the payments to continue to process them.”

“Further defaults on future coupon payments are likely,” it states.

DiPippo says bondholders will need to decide whether to press for immediate repayment by seizing assets. “That will be difficult during a war,” he says, “in part because only overseas assets would be accessible. However, if Russia’s frozen reserves were used to make payment, it would essentially be doing what Russia wants, as Moscow wants to make payment.”

Unlike many emerging markets, Russia has not waived sovereign immunity as a condition of its bonds, DiPippo says. This will complicate legal proceedings and could possibly delay a settlement in the future.

Until the war in Ukraine, the financial messaging network Swift (Society for Worldwide Interbank Financial Telecommunication) was only known to payment nerds and the more than 11,000 banks in 200 countries that use it every day to securely transmit messages pertaining to financial transactions. 

In addition to wide-ranging economic sanctions, cutting Russian banks off from the financial messaging network—“de-Swifting”—is the West’s tip of the spear against Russia. In March, the European Commission (EC) announced that seven banks, including Russia’s second largest bank, VTB, would be de-Swifted. Then in May, as part of the EU’s sixth sanctions pack-age, the EC announced that Russia’s largest bank, state-owned Sberbank, would also be cut off.

The Institute of International Finance (IIF), estimates that close to two-thirds of Russia’s banking system, in asset terms, will have lost access to Swift once the EU’s sixth package is implemented. Given Sberbank’s size and importance in Russia, cutting it off from Swift is potentially “game changing,” says Nicolas Véron, a senior fellow at Brussels-based economic policy thinktank Bruegel. But the EU continues to buy oil and gas from Russia, he adds. That means the EU is unlikely to deSwift all Russian banks.

Plus, European banks can still transact with Sberbank, so long as the messaging pertaining to those transactions isn’t transmitted via Swift. Banks could communicate via fax, for example, but it is more cumbersome. 

David Sacco, a practitioner in residence in the finance department at the University of New Haven, says the West is engaged in a delicate geopolitcal “dance with the Russian banking system.” 

“We have this lever [Swift] we can use, but we can’t completely cut Russia off from the dollar banking system because the consequences would be severe,” Sacco says, pointing to the potential to spark civil unrest. “But we need to continue to point out to them that we can use Swift.” However, such weaponization of Swift in geopolitcal negotiations continues to stoke debate among countries  such as Iran, China, Venezuela, and India as well as Russia:

Should they seek alternatives to Swift explicitly to diminish its power to cut them out of the global financial system? 

Central bank advisor Philippe Tissot believes the recent sanctions could strongly encourage Russia, and other countries, to accelerate gateways between digital currencies, sapping the power of the Swift system. “The consequences on the global financial system, whose mission is to manage financial flows, would be to accelerate the implementation of CBDCs and cryptocurrency exchanges,” he said shortly before cryptocurrencies went into freefall, alongside other risk-based assets.

But with close to 12% of the Russian population (17 million individuals) possessing crypto wallets, the second-highest share globally, it is a scenario not too difficult to imagine unfolding. The IIF expects “crypto-related issues [to] gain in importance as financial sector sanctions weigh on Russia’s ability to conduct cross-border transactions,” it wrote in a June note. 

Before the war, Russia’s central bank planned on banning crypto assets. Now the IIF says it is preparing to legalize and regulate them, and is expected to issue its own digital ruble by the end of the year. The IIF says the decentralized nature of blockchain technology and crypto cur-rencies could help Russia avoid sanctions. 

However, these digital tools are available to all, not just Russia. “Blockchain can be used by incumbents as well as disruptors,” Véron says. “Swift could offer a service using this new technology as much as anyone else.” 

Yet, cryptocurrencies are unlikely to provide a satisfactory alternative as the  US and EU have sought to close any crypto-based loopholes in sanctions. Secondly, according to the IIF, the global crypto market is insufficient as a channel for broad sanctions circumvention due to its volatility and relatively small market capitalization, which slumped under $1 trillion for the first time recently.

Alternatives Under Construction

Following the deSwifting of seven Russian banks back in March, Venezuelan president Nicolas Maduro told Telesur, a Latin American terrestrial and satellite television network: “Fortunately, we don’t run bank-ing with the Swift system. We are happy not to operate a banking system dominated by countries that promote destabilizing actions in other nations.”  Venezuela runs bank transactions with its own digital cur-rency, the Bolivar, Maduro added. 

In light of the sanctions imposed by “unfriendly countries,” Russia’s cen-tral bank is also  ramping up efforts to connect additional international partners to its System for the Transfer of Financial Messages (SPFS), which routes transac-tions between Russian banks without using Swift’s infrastructure. As of March 2018, an estimated 400 banks (mostly Russian) were believed to be connected to SPFS, while 23 foreign banks from Armenia, Belarus, Germany, Kazakhstan, Kyrgyzstan and Switzerland are said to have joined the system in 2020. 

The Indian government is considering a proposal to use Russia’s SPFS for rupee-ruble-denominated payments. Iran, also cut off from Swift, is also reportedly mull-ing Russia’s alternative messaging system. There is talk of similar agreements with China, and the Eurasian Economic Union. 

However, in a June 1 note on Russian sanctions avoidance, the IIF states that, “the specific jurisdiction of the payments messaging is somewhat beside the point; the real issue is the US’s and EU’s abil-ity to punish institutions for interacting with Russian counterparts and, underly-ing that, the ability to track transactions.” It seems there is no easy escape from the long arm of sanctions from the West.

Moreover, building a system on par with Swift’s is not so straightforward. “It’s not just about having a messaging service to rival Swift,” says Gerard DiPippo, senior fellow in the Economics Program at Washington-based think tank, the Center for Strategic & International Studies (CSIS). “You need a settlement or clearing service that is not reliant on the dollar. You would also have to build, he adds, “a non-US dollar ecosystem that has a strong network effect.” 

No such system currently exists. He calls Russia’s SPFS “measly” compared to Swift. And while China is making strides in fostering cross-border use of the renminbi—its renminbi-based Cross-Border Interbank Payments System (CIPS) the-oretically could serve as an alternative to Swift and Western clearinghouses—DiPippo estimates that 80% of the trans-actions on CIPS continue to message through Swift, for convenience. 

“The value of Swift is that everybody uses it,” says Véron. “You may use an alternative system, but if the rest of the world doesn’t follow you, you lose that network effect.”

Furthermore, CIPS doesn’t insulate users from sanctions. “US detection capa-bilities are pretty good, and banks are aware of that,” DiPippo says. “There is nowhere to run if you want to be connected to the international financial system.”

The withdrawal of Visa and Mastercard from Russia also raised expectations that China’s main card scheme, UnionPay, would easily step in and replace them. But no evidence has emerged so far. “By and large China is mindful of complying with sanctions,” Veron says. “We haven’t seen anything to support the view that it is willing to disconnect itself from the global financial system to increase finan-cial integration with Russia.” 

Perhaps the only factor that could chal-lenge the global financial system and the market infrastructures like Swift that sup-port it, is reduced dollar dominance. That’s unlikely, at least in the near term. “We are seeing a marginal realignment towards smaller currencies,” says DiPippo. “But the only thing that could unseat the dollar is if the US screws up by letting inflation go nuts, or it defaults on treasuries. However, I can’t imagine a scenario where a bunch of regional currencies displace the dollar. There’s still the network effect.” 

As the West continues to punish Russia economically, many are wondering whether these efforts can stop Vladimir Putin’s war machine. In the early phase of the war in Ukraine, the ruble lost almost half its value and there were reports of empty supermarket shelves. Photos of Russians queuing to withdraw money from ATM machines circulated on social media as the reality of life under wide-ranging economic sanctions set in.

But with the conflict now in its fifth month and showing no signs of slowing, Russia’s economy has withstood the unprecedented sanctions better than expected.  

“In Russia, there has been some economic pain, but the sanctions have not been as quick and impactful as some expected at the start,” says Cvete Koneska, who leads London-based security intelligence firm Dragonfly’s global advisory practice. “The question is: Can we find other ways to make sure Russia stops the war?” Koneska says there needs to be more dialogue with non-EU and NATO countries as Western economic sanctions can only achieve so much.

Thanks to swift action by the Russian central bank—including capital controls and a substantial hike in interest rates—the ruble largely recovered the losses from during the initial invasion. Furthermore, surging oil and gas revenues are pouring into government coffers. Moscow’s June default on international debt obligations was the first such foreign-bond default since 1918—more than 100 years—but seems not to have changed much on the ground for Russia, at least not at this stage.

Usually, when a country defaults on international debt obligations it is a sign of a weakening economy. But Russia was making a good-faith effort to service its bonds when it technically defaulted on June 26, blocked from transferring the funds because its National Settlement Depository is under EU sanctions. 

“Moscow argues that it’s not really in default, as it’s trying to make repayment,” says Gerard DiPappio, a senior fellow in the Economics Program at the Center for Strategic and International Studies (CSIS) in Washington D.C. “In general, this is likely to matter to future investors in Russian bonds, as the default is more technical/forced rather than a sign of Moscow’s unwillingness to make payment. Future investors will of course care about geopolitical risks, and the potential for renewed sanctions might push up Russia’s borrowing costs. But that’s more a function of the sanctions than the default per se.”

DiPappio estimates that Russia only has approximately $20 billion in foreign-currency Eurobonds, which is quite small relative to the total emerging market bond universe. “Russia does not have large foreign debts,” he explains. “Part of Moscow’s ‘fortress Russia’ strategy after 2014 was to minimize government debt and maximize reserves.”

Longer term, the question is whether the technical default could affect Russia’s ability to borrow externally from other countries bilaterally (which is unlikely, but possible) or even whether it will be able to return to international bond markets after the war or whenever sanctions are lifted. But given that Russia continues to export close to $1 billion per day in oil and gas, about half of which flows directly into Moscow’s coffers as government revenue, it doesn’t have an urgent need at this point to borrow from international debt markets.

“Moscow has been adding to its reserve funds, not depleting them,” says DiPappio. “Those revenues would need to decline substantially (probably requiring some energy market disruption) to swing Russia’s finances into deeply negative territory. If that happened, Russia would still have its roughly $200 billion reserve fund, probably at least half of which is accessible.”

Russia’s friendly/neutral partners in the developing world, specifically China and India, are unlikely to care about the default. “Russia is relying on them as marginal buyers of its oil,” DiPappio explains. “Going forward, Russia will particularly rely on China as a source of second-best industrial/tech goods as substitutes for goods under sanctions.”

What we usually see with cases of sovereign defaults we are unlikely to see with Russia. However, Koneska says there could be bigger changes afoot due to a new understanding of geopolitical risks, and changes in the world financial system sparked by response to Russia’s invasion of Ukraine and the international response. “Based on the rhetoric coming out of Russia,” says Koneska, “I get a sense of a kind of rejection of how the international financial system works, and a feeling that the system is set up unjustly for Russia, so they need to create a different one if they are to continue trading on terms that seem fair to them.”

In order to diverge from existing trade and financial systems, Koneska says at some point in the future Russia could set up its own economic and trading bloc with countries like India, Iran, China, and the CIS countries, which are sympathetic to its plight.  “It would not be easy,” she says, “but it could be the start of many new [economic] centers that may take shape in future.”