Agora Risikoreport Sonderedition Ausblick zweite Jahreshälfte: Krieg, Energieknappheit und Machtfragen in den USA und China sorgen für Volatilität

June 13, 2022 | MENA Region

Executive Summary Despite its rapid expansion since 2013, China’s Belt and Road Initiative (BRI) has been slowed by both the COVID-19 pandemic and Russia’s war on Ukraine . The EU’s Global Gateway policy, and the American-led Build Back Better World (B3W) global infrastructure initiative of the G7 have emerged as the key rivals to the BRI . So far, though, the West’s alternatives to China’s BRI are beset by lack of specific projects and an overreliance on risk-averse private capital necessary for planned public-private partnerships. Implications for International Business The current headwinds for the BRI, including dissatisfaction in receiving countries, provide opportunities for Western firms, especially in green energy and health infrastructure. Companies seeking to capitalize on B3W and Global Gateway programs, however, face high economic and political risk in infrastructure projects in Asia, Africa and Latin America. State of Play Infrastructure development as a foreign policy tool In the last decade, the countries financing and building overseas infrastructure have increasingly linked their investments to geopolitical and commercial goals. China’s Belt and Road Initiative (BRI), the signature foreign policy of President Xi Jinping, is the most renowned of such efforts. Divided into an overland “belt” and a maritime “road”, it has enabled Chinese banks and firms to develop transport, energy, and digital infrastructure from Asia to Europe and extending to Africa and Latin America. While expanding rapidly, BRI has resulted in controversy about unsustainable debt and climate impacts in developing countries, even before the COVID-19 pandemic and now the Ukraine war have slowed its momentum. In the meantime, countries like Japan and the United States began to promote “high quality” infrastructure alternatives, culminating in a 2021 G7 commitment to pursue a Build Back Better World (B3W) agenda to counter China’s BRI. The EU’s December 2021 Global Gateway strategy, building on an earlier EU “connectivity strategies”, is only the latest such program and open to complement B3W. Key Issues The West facing challenges in countering China’s BRI Western governments’ efforts to – often implicitly – offset China’s influence through own infrastructure programs face a number of challenges. First, despite expressed commitments to cooperate and coordinate, these strategies, including Japan’s “Partnership for Quality Infrastructure” and the UK’s “Clean and Green Initiative,” so far are long on lists of priority areas and short on details about actual implementation. Next, China has relied on state-owned “policy banks” to finance, and on state-owned firms to construct, BRI projects. Yet, Western programs rely on private capital in often high-risk settings. Concerns about the sustainability of political support for Western BRI alternatives constitute another challenge, especially given the volatility of American politics and the slow member state take-up of the EU’s Global Gateway. Without clear and concrete achievements as proof-of-concept, emergent Western alternatives to the BRI may soon lose focus and momentum. Moreover, the appeal of China’s “development”-focused, “South-South” framing of its relations with partner countries is hard to beat. Despite the debt impact and environmental concerns about the BRI, developing countries are attracted to China’s basic proposition that building infrastructure drives economic growth and that China’s hands-on support gets infrastructure projects built. The West’s efforts to offer a geopolitical alternative, in contrast, has been hampered by the perception that it does not adequately understand the needs of developing countries. Governments in Southeast Asia, Africa or Latin America will assess B3W based on what it can actually provide and will welcome viable competition to Chinese offers – but, less so if they are asked to explicitly reject or criticize China as part of the deal. Global infrastructure competition bears new geoeconomic risks and opportunities In the past decade, China has used trade, investment, and financial interdependence to boost its political and geostrategic leverage over its immediate neighbors and BRI partners worldwide. The rationale behind the alternative initiatives now promoted by the U.S., the EU and others is not to cede opportunities and influence in specific regions and sectors to China. The “Indo-Pacific” will be a focal point for competing Western and Chinese spheres of influence over different types of connectivity, especially as the EU and the U.S. included elements of their infrastructure-promotion plans into their newly articulated strategies for this region. Besides Southeast Asia, the EU’s Global Gateway will focus more on Africa while the U.S., through B3W, will seek to provide infrastructure alternatives in Latin America and the Caribbean. Also, as Russia’s war on Ukraine has highlighted the importance of energy security, including the role of both traditional fossil fuels and alternative energies, the nascent Western initiatives will likely focus on promoting the energy transition in the Indo-Pacific and beyond. The global economic volatility and the uncertain outlook on the COVID-19 pandemic add to the difficulty of assessing and managing financial and political risks associated with infrastructure development in developing countries through “building back better” initiatives. China itself has not always understood or managed such risks well. Examples include massive unpaid loans to Venezuela or Myanmar’s backlash over disputed dam and mining projects. Already before 2020, China began drastically scaling back the size and scope of its policy bank lending to partner countries. Although Western governments focus on mobilizing private capital as part of B3W and Global Gateway public-private partnerships, they will have to confront the headwinds of tightened monetary policy and the end of the era of cheap capital. Western firms are thus likely to be even more sensitive to financial and political risk for large infrastructure projects. However, as countries seek alternatives to Chinese-backed coal-fired power plants or from dependence on Chinese digital infrastructure, Western governments and companies should have both economic and political openings. But, to be successful, they have to provide clear and viable financial and technological packages that respond to host countries’ needs and realities. A clear starting point would be to build on the new EU-U.S. Trade and Technology council to establish effective demonstration projects in the field of digital trade in Southeast Asia.

Executive Summary Increased living costs in France are at the center of the debate in the presidential run-off between the incumbent Emmanuel Macron and his far-right challenger Marine Le Pen on April 24. While Macron is betting on a major investment plan aimed at boosting France's productivity, Le Pen has chosen the national checkbook method , promising to “return money to the French”. France’s foreign policy is at a crossroads as French voters will decide between multilateralism and European integration, or a withdrawal from NATO’s command and a threat to western unity. Implications for International Business Discontent over welfare reforms and rising food and fuel prices will cause large-scale protests regardless of the election outcome, possibly disrupting operational flows and logistics. A Le Pen victory would additionally worsen France’s business climate due to a protectionist, anti-globalization agenda already rattling French bonds and banking stocks. State of Play Tough battle on spending power and political restructuring: nothing is decided yet The first round of the presidential election marked the end of the two traditional governing parties, the historic Gaullist party, Les Républicains (4.78%), and the Socialist Party (1.77%). Both alternated in power between 1958 and 2017, when centrist reformer Emmanuel Macron from En Marche became President. The incumbent will face off Marine Le Pen from the far-right Rassemblement national in a second round . Poll projections suggest a tight race. Despite a faster than expected post-Covid-19 economic recovery, purchasing power and the cost of living are the main campaign themes. In the face of Russia’s war against Ukraine exacerbating already high inflation, other themes such as the pandemic, climate change, immigration, and security were eclipsed. Moreover, the next president will face the challenge of securing a cohesive parliamentary majority in subsequent legislative elections. Even if Macron prevails in the presidential contest, En Marche is expected to lose seats in the National Assembly, making it necessary to broaden their alliance to govern effectively. In turn, a Le Pen victory would inevitably lead to a new French "cohabitation" as voters try to block a far-right parliamentary majority. The pension reform that Macron promised in 2017 but postponed due to the ‘Yellow Vests’ motorists protests and the pandemic, is expected to cause a political stir with massive social unrest in the coming months. Key Issues Protectionism vs. economic reforms: the election’s economic implications Emmanuel Macron sticks to a strategy of investment in the French manufacturing industry, as evidenced by his recent France 2030 plan, aimed at fostering innovation and industrial revival. The plan foresees spending 30 billion EUR on the ecological transition including reducing of carbon emissions as well as on the digitization and revitalization of industrial sectors like automotive, aerospace, biotechnology and healthcare. In parallel, Macron is committed to attracting foreign investors with his "Choose France" program. As announced in January 2022, this program’s fifth annual campaign is expected to inject more than 4 billion EUR into the French economy. Among the 21 new, mainly industrial projects are companies such as American chemicals firm Eastman, which is building a new plastics recycling plant in France. Unlike Macron, Marine Le Pen targets working-class core voters and defends above all measures of redistribution and social protection. In the absence of a real innovation policy, Le Pen sells a softened protectionism with focus on strengthening import controls, protecting the French economy from perceived unfair competition by ending posted work of employees carrying out a service in another EU member state on a temporary basis, prioritizing small and medium-sized companies in public tenders, and revising free trade agreements deemed not in France's interests. Le Pen also favors replacing the current property tax with a wealth tax directed at the rich, exempting primary residences. The two presidential candidates share a common desire to lower taxes without reducing public spending. Economists warn of the risk of deficits and debt slippage. Macroeconomic projections show that Le Pen's program, which blames the debt of previous governments, would increase it by five points of GDP, exceeding 3500 billion euros, 237 billion euros more than Macron's program. With the two programs, France's trade balance should also still be in deficit in 2027 (-2.6% and -2.8%). Macron vs. Le Pen: High stakes for Europe and the West As the second largest EU economy, with the only EU seat in the UN Security Council and as the EU’s sole nuclear power, France plays an important strategic role. The current presidential election therefore constitutes a defining moment for France’s foreign policy. While Le Pen’s priority is to withdraw from international institutions in an attempt to regain sovereignty and independence, Emmanuel Macron is convinced that France's interest lies in becoming more involved in global affairs through multilateral organizations. Macron strives for European sovereignty in response to supranational challenges, such as European defense, energy self-sufficiency, rising public debt, and future pandemics. After her defeat in 2017, Le Pen formally renounced her plans for a French departure from the Euro area (“Frexit”). A Le Pen victory now would still have a major impact on European governance. As a Eurosceptic, she plans to create an “Alliance of Free and Sovereign Nations” with Poland and Hungary to gradually replace what she sees as a “Federalist European Union”. This is a strong risk of political paralysis, both in Paris and in Brussels. Beyond the EU, Macron is also more committed to a strong transatlantic alliance. Despite characterizing NATO as “brain dead” in 2019 amidst the lack of coordination between then-US president Donald Trump and Europe as well as the unilateral behavior of Turkey, Macron strongly supported the alliance in the wake of Russia’s war on Ukraine. In turn, Le Pen opts for a French withdrawal from NATO's integrated command, claiming that the alliance’s Eastern expansion is the main reason for the war in Ukraine. Le Pen’s party has maintained strong ideological and financial ties with the Kremlin, receiving public support from Russian President Vladimir Putin in 2017 and several loans from Russian banks. Le Pen advocates for a strategic convergence between NATO and Russia within a new security architecture in Europe. Despite the US-French quarrel over a multibillion deal to supply Australia with submarines, US President Joe Biden and Macron are now on solid terms. At a time when Washington is trying to strengthen a Western coalition by relying in particular on Paris, the rise of a nationalist-populist candidate who is very critical of NATO and close to Russia is not reassuring across the Atlantic.

Executive Summary With new and expanding Covid-19 lockdowns in important industrial centers, China’s domestic economy will be slowed, requiring more fiscal and monetary stimulus to meet 2022 growth targets. Despite Chinese government claims of its ‘limitless friendship’ with Russia, China continues its wait-and-see approach to the war in Ukraine, all the while attracting growing Western ire. Concerns about international and domestic market volatility prior to China’s important Party Congress in the fall of 2022 mean Chinese leaders will emphasize economic and social stability. Implications for International Business Growing supply chain disruptions may result from intermittent lockdowns of manufacturing and export centers along China’s Eastern coast Increased government efforts expected to drive market stability, particularly regarding domestic real estate and tech platforms as well as limited appetite for future deal-making with Russia. State of Play The Challenges of “Dynamic Zero Covid” in China China’s zero Covid strategy had kept infections to a minimum for two years, but the virus is resurging. While the main impact has been in Hong Kong, where a rapidly increasing death toll has led to social anxiety, the mainland is experiencing its largest wave since the original Wuhan outbreak. Most recently, the manufacturing and export hub Shenzhen was locked down, with potential knock-on effects on tech and other supply chains. China’s leaders will maintain the zero Covid policy until the Party Congress to ensure social stability. Meanwhile, reaching the targets set by the National People’s Congress (NPC) of 5.5% economic growth, 3% inflation, and the creation of 11 million new urban jobs, will require significant fiscal and monetary efforts. These include enhanced support for domestic semiconductor production, linked to longer-term efforts to promote technology innovation and self-sufficiency, as well as support for pandemic-hit sectors such as travel and tourism. The tax burden on SMEs is expected to decrease while spending on infrastructure aims to boost local revenues and employment. Key Issues China’s Economy: Government-Induced Optimism Despite Strong Headwinds In Q2 2022, China’s economy faces important headwinds. Besides the rise in Covid infections, these include real estate sector woes linked to a crackdown on lending to over-indebted firms like Evergrande and the economic and political fallout from Russia’s invasion of Ukraine, including rising prices for energy imports. To boost flagging real estate investment, the government vowed to hold off on proposed new property taxes while also reducing mortgage rates. The government has pledged to support green consumer technology for household appliances and electric vehicles, especially in rural areas, thus providing potential opportunities for foreign firms. Given the importance of foreign investors in key Covid-impacted manufacturing and export hubs in the Pearl River and Yangtze River deltas, local officials may prioritize revitalized commerce over strict regulatory enforcement. While some U.S. and European firms will continue to diversify parts of their sensitive technology supply chains to Southeast Asia, Europe and North America, there is little indication of wholesale supply chain relocation away from the mainland. ​ Key for both Chinese and foreign firms was the government’s response to extreme volatility in China’s equity markets since the NPC’s conclusion in early March. The MSCI China Index was down nearly 30% for the year on 15 March, prompting Vice Premier Liu He to commit to support Chinese firms’ overseas IPO listings and “stabilize” the domestic market, including struggling technology platforms like Alibaba. Given increased uncertainty in international markets related to concerns about rising commodity prices and industrial supply chains, and the range of domestic economic challenges, China’s top economic officials are keen to minimize market volatility in the lead-up to the 20th Party Congress this fall. The Challenges of China’s “limitless friendship” with Russia In recent years China intensified its political and economic relationship with Russia for strategic reasons. The two president’s declaration during the Winter Olympics that the two states’ friendship “has no limits” as well as a US$118 billion oil and gas deal symbolized this trend. Yet, there are limits to the economic dimensions of this partnership that will constrain future cooperation in the wake of the war in Ukraine. Russia is a key energy partner for Beijing. However, China has been eager to diversify its energy sources and will have heightened awareness of Russia’s willingness to use its energy supplies as a tool of coercion. Despite China’s recent lifting of restrictions on Russian wheat exports, China imports less than 6% of its domestically consumed wheat. In addition, Chinese state-owned and private firms are strongly integrated into global supply chains and financial markets and are wary of being cut off from the SWIFT payments system if they run afoul of Western sanctions against Russia. ​ Moreover, Chinese shipping, port and commodity firms have built up trade, investment and logistics ties with Ukraine, signing nearly US$7 billion in investment contracts in 2021. China will not only be leery of the war’s impact on its interests in Ukraine, but it will also be loath to see large swaths of the Belt and Road Initiative (BRI), which lie along Russia’s former or current sphere of influence in Central Asia and Eastern Europe, destabilized. As part of any ongoing withholding of criticism of Russia’s war in Ukraine, expect China to demand a large discount on Russian oil, gas and transshipment infrastructure. In the past, such demands have stymied the completion of Russian oil and gas pipelines to China and led to years of stalled negotiations on long-term contracts. Three scenarios in the evolving China-Russia relationship exist, out of which the first is the most likely: (1) despite continued anti-US and anti-NATO rhetoric, China bargains with the West over terms to moderate its support for Russia by demanding assurances that it will not be hit by sanctions nor targeted by an Asian version of NATO; (2) China reverses course on its support for Russia by playing an active role in mediating a peaceful settlement to the war; (3) China doubles down on its support for Russia’s invasion of Ukraine through increased military and economic assistance in return for Russian support for China’s claims to Taiwan. Xi Jinping will not use military means to reunify China and Taiwan in the near future. While strong US signals deter China from any provocative behavior in Taiwan, China will push to isolate Taiwan.

Executive Summary The low cost of conducting cyber-attacks and the impunity of the perpetrators has led to an increase of both the incidents and their severity, including government-sponsored acts. Amid the growing geopolitical rivalry in cyberspace, the emphasis by great powers is placed on spying on adversaries and strategically using existing information to weaken opponents. So far, the cyber dimension of Russia’s war in Ukraine has translated into few damages for international firms, but companies must remain vigilant and brace for unintended consequences. Implications for International Business Companies should increase their cybersecurity, since Russian cyber operations against Ukraine are likely to have accidental effects outside the immediate conflict zone. Beside a cyber risk assessment, building redundant parts into systems can drive firms' cyber resilience. A major quarrel over who pays for cyber incident damages is fought between companies and insurance firms, with the former having had some success recently. State of Play The rise of cyber offensive capabilities renders cyberspace more dangerous Cyberspace consists of the network of information technology infrastructures and resident data, including the internet, telecommunications networks, computer systems, and Internet of Things (IoT) devices. The main drivers of cyber threats are the low cost of conducting such attacks and the likely impunity of the perpetrators. While criminals often conducted cyber-attacks in the past, attacks have also become state-driven. For the past eight years, Russia has led disruptive cyber operations against Ukraine’s energy sector (shutting down power plants), election infrastructure (meddling with tallying of votes), public sector (using data wiper malware), and financial institutions (overloading of bank websites). In turn, within a few hours of Moscow’s invasion of Ukraine, the hacker group Anonymous responded by declaring a “cyber war” on the Russian government. Anonymous disabled the websites of Russian state TV channels, the Kremlin, and the Duma. To protect its critical infrastructure, the EU is revising its directive for network and information systems security (NIS2) to require telecoms providers, banks, energy grid operators, and other critical services to promptly report cyber incidents to national authorities. The Cyber Resilience Act, another EU legislative act expected for Q3 2022, introduces joint certification standards for IoT devices. Key Issues Cyberspace as new playground for great power competition Russia has for years worked towards creating a national state-controlled alternative to the privately-owned internet that is common in most other countries. The increasing regionalization of the internet raises the cost for businesses that have to comply with diverging national technical standards and that have to establish local data storage centers. The Kremlin has also been notorious for leveraging cybercriminal groups to achieve geopolitical goals. It has tolerated cybercrime activities emanating from Russia as long as these spared Russian businesses or individuals. When Western businesses and government entities were targeted abroad it played into Russia’s goal of highlighting the weakness of democracies. Non-state actors provide plausible deniability for Russia. During the major cyberattacks on Estonia in 2007, Russia fended off any criticism by claiming non-state actors had conducted these attacks. This rhetoric continues until today. ​ An important dimension of geopolitical cyber rivalry is spying on adversaries and strategically using information to weaken opponents. In Germany, Russian hackers targeted members of the Bundestag in the 2021 Ghostwriter campaign, supposedly aimed at leaking information to embarrass the MPs and compromise their online presence. As Putin’s current war against Ukraine shows, the military dimension of cyber operations appears to be for now much subtler, given that no cataclysmic cyber operation has yet been observed against Ukraine with the exception of the cyberattack against satellite network provider Viasat, which limited the Ukrainian military’s situational awareness at the onset of the invasion. In cyber, intelligence also aligns with ideological factors. China is one of Russia’s few partners in the global cyber competition, assisting Moscow to shield off the Russian information environment from the world. Sino-Russian technological transfer may face major challenges, especially due to US sanctions on Chinese equipment. If Russia used the equipment in its own products, it would violate sanctions and it would be unable to export any of that equipment abroad. Geo-economic consequences for international firms Geo-economic consequences for international firms So far, the major geo-economic consequences of the current cyber rivalry have been unintended. The Russian NotPetya malware was meant to target Ukraine. But, as the code was written hastily, it also disrupted the global operations of German multinational Beiersdorf, logistics giant DHL, Danish shipping company Maersk and many others. It is believed to have been the costliest cyberattack in history. Insurance companies have been in the spotlight in the discussion about how to mitigate the costs of such attacks. In January 2022, Merck, a pharmaceutical company also affected by NotPetya, won a lawsuit against insurer Ace American. The insurer had claimed that the malware was an “Act of War”, which it cannot cover. A U.S. court decided, however, that Ace American had failed to update their policy language to include cyberattacks as acts of war and that Merck will be compensated for damages of up to $1.4 bn. ​ Much damage can be avoided when businesses conduct a cyber risk assessment, mapping their assets, identifying potential risks, and defining mitigation measures. To ensure the continuation of business operations, redundant parts must be built into systems, thus increasing resilience. For example, backups which are segregated from the rest of the company can quickly turn companies operational again after a ransomware attack. In a business where the confidentiality and integrity of data is of utmost importance, encryption within company networks as well as multifactor authentication can fend off most attacks.

Executive Summary Even without a Russian attack on Ukraine, Europe’s energy crisis is set to worsen The Kremlin has manufactured a crisis in Europe to achieve political and strategic goals regarding both Ukraine and NATO, with an endgame that remains obfuscated but could result in war. As last-minute shuttle diplomacy to avert military aggression against Ukraine is underway, the broader effects on Europe’s energy security will be felt for much longer. While China does not contribute to defusing the crisis, it plays an important part when it comes to exerting sanctions pressure on Russia should deterrence and de-escalation fail. State of Play A Kremlin-engineered military crisis in Europe Europe is facing the immediate threat of war, as Russia has amassed 150.000 combat ready troops at Ukraine’s borders, in Belarus and on landing ships entering the Black Sea. Despite U.S. efforts to expose Russia’s plans and thereby remove the element of surprise, this year-long buildup amounts to the largest concentration of troops in the region since World War II. Amid high-level phone calls and shuttle diplomacy by Western leaders, Moscow insists to turn Ukraine into a ‘buffer zone’ to protect itself from perceived military encroachments from NATO. Yet, Washington is convinced that President Vladimir Putin’s ultimate goal is war and partitioning of Ukraine, despite substantiated threats of unprecedented economic sanctions from both the U.S. and the EU. So far, the crisis has been unfolding on Russia’s terms, and the current stalemate leaves the West with few options. Key Issues Europe is facing a worsening of the existing energy crisis amid standoff with Russia In case of war, there will be severe consequences even beyond the disruption of business in and around Ukraine. On the energy front, Russia will not immediately stop shipping gas and oil to Europe because it relies on those revenues. The U.S. is also unlikely to push for an all-out embargo, given the severity of the energy crisis in Europe and global inflationary concerns. For 2022, Europe is expected to spend $1trn on energy, up from $500bn, even without a reduction in Russian gas supplies. Sanctions to target Russia’s financial sector will be priced by markets as a risk factor even without an actual tightening of supply. In turn, Western markets will see sectoral sanctions potentially affecting prices in metals (iron, copper, etc.), chemical production, machine parts, and timber. Furthermore, major risks to Europe’s natural gas supplies stem from disruptions of Ukraine’s direct supplies to Europe in case of war. Plus, the certification of Nord Stream 2 will be stopped, suspending the project for the foreseeable future, if not altogether. While Russia has enough pipeline capacity to pump gas through Nord Stream 1 beneath the Baltic Sea and the Yamal-Europe pipeline via Belarus, the Ukrainian route would be vulnerable. Internally, Russia would, however, be less hit, since oil sales contribute significantly more to its budget (55%+) than gas exports (ca. 15%). In the short run, Europe would likely be able to obtain additional gas from the U.S. and the Gulf region to prevent further price hikes. War in Ukraine would also be an incentive to restore the nuclear deal with Iran and resume imports of Iranian hydrocarbons. However, it takes around five years to launch new gas projects, and the trans-Caspian pipeline from Central Asia is unlikely to materialize due to strong opposition from Russia and China. Europe will thus need to speed up its energy efficiency efforts, while trying short-term fixes through coal and oil-fired power generation and possibly the extension of other energy sources in the medium-to long-term. China wisely weighs its economic interests to decide how to back its junior partner Russia China publicly supported Russia’ demand vis-à-vis NATO in a joint statement by Presidents Putin and Xi Jinping in early February. Yet, should war erupt, Beijing is unlikely to take a public stance; instead, it may react similarly as during the 2014 annexation of Crimea: no criticism of Russian actions, but no overt support for war, coupled with calls for peace. One immediate effect of military conflict on China would be through its substantial wheat imports from Ukraine as well as the functioning of the country’s ports in Odessa and Nikolaev. Already, Beijing is looking to Latin America and Russia for a diversification of grain imports. In the coming weeks, China will carefully monitor the introduction of new sanctions by the U.S. and the EU, avoiding transacting with U.S. designated entities as it did in the wake of 2014. However, China will exploit all legal means through its policy banks (ExIm, China Development Bank) and will create special infrastructure to work on some projects with Russia (as it does in Iran and North Korea). The most sensitive parts of the relationship, including the supply of Chinese-designed semiconductors and chips, will be moved to secrecy. A likely byproduct of the crisis will be the increased use of yuan instead of dollar and euro in business with Russia, despite existing capital controls. Chinese leverage will increase, driving up Russia’s reliance on China, and rendering the partnership more unequal. Some projects will thus be executed with significant concessions, e.g. the 50 bcm/year Power of Siberia 2 project that will bring gas to China from the same Yamal fields that serve Gazprom’s customers in Europe. All told, while carefully calibrating its response to the conflict itself and to possible Western sanctions, China will gradually move closer to Russia in joint opposition to the U.S. and an attempt to challenge the existing world order.

Executive Summary Washington ponders new mechanism with unknown effects The US is weighing the benefits of outbound investment screening (OIS) to counter China. Introducing de facto capital controls requires Europe’s support, putting the transatlantic relations to a test. The goal of OIS is “soft decoupling” to prevent the offshoring of increasingly discrete supply chains in aerospace, semiconductors, AI, IT, robotics, and other critical tech sectors to non-allied third countries. Introducing OIS carries risks of protectionism and capital relocation, curbing freedom of invest­ment and the (partial) restructuring of businesses in emerging tech State of Play A new tool of economic statecraft in Washington The idea of introducing a – US-only if needed, but preferably transatlantic – outbound investment screening (OIS) is gathering steam. This mechanism aims to screen and, eventually, ban certain US and European investments into critical tech sectors in non-allied third countries. The implicit goal is to prevent China from acquiring critical technologies through political pressure and, effectively, capital controls. Yet, capital controls increase economic costs and risks for American and European companies – from compliance burdens and higher risk premiums to a loss in strategic competitiveness. Washington’s actions are guided by geopolitical, not commercial, reasoning. The Biden administration is likely going to make it a central request to Europeans in confronting China. Many European countries are skeptical, but prioritize a strong transatlantic partnership. Furthermore, EU governments see increasing risks in being tied to Beijing-controlled tech supply chains. Key Issues The idea behind Outbound Investment Screening – and how it could work OIS is part of the Biden administration's emerging technologies strategy. Its formulated objective is to shield America’s – and by extension the transatlantic – ‘technological ecosystem’, avoiding ‘disadvantageous’ supply chain relationships. The administration and Congress seem to have a three-fold rationale for promoting this mechanism: (1) efforts in other areas including the US-EU Trade and Technology Council (TTC) do not sufficiently cover critical technology offshoring, and (2) existing export controls and inbound FDI screening can be circumvented by investments into entities abroad. Furthermore, (3) OIS would be a suitable political lever to increase pressure on the systemic rival given China’s strong interest in critical tech investments. In practice, OIS rather entails reporting requirements for specific tech sectors (e.g. semiconductors, AI, and robotics) along the lines of inbound FDI screening. Based on certain screening thresholds, the administration would thus acquire a means to prohibit certain investments abroad. However, Washington needs Europe on board, especially high-tech countries like Germany, the Netherlands, Sweden and France. The mechanism obviously cannot succeed if European investors were to simply substitute US investment banned by a unilateral screening.The US and Europe will therefore have to identify in which specific technologies and how far down the supply chains they would like to control access via OIS. In fact, the EU-US agreement on Airbus-Boeing of June 2021 could be a starting point for transatlantic OIS, beginning with aerospace and expanding into other sectors. Challenges for European businesses and governments OIS comes with a range of economic challenges, technical difficulties, and risks for businesses. First, it enhances decoupling and promotes protectionism. Affected tech sectors could disintegrate, and companies might have to undergo serious restructuring. Screening decisions could be driven by politics, not least because criteria are vague. European firms would lose out if the US protects its companies differently than the EU, given that capital controls are prohibited by EU law and WTO rules. Second, OIS will likely increase the compliance burden and restrict investors and businesses. Third, investors could possibly move to other locations from where they can invest more freely, i.e. with no OIS restrictions. This is why forming a broader coalition beyond the US and Europe is important, albeit probably difficult to achieve. Fourth, it is unclear how OIS will work technically, as capital can move within (micro-)seconds, whereas regulators would have to intervene retroactively. This would cause disruptions to operations for which businesses could not expect damage compensation. Furthermore, alternative payment methods such as crypto currencies can complicate an effective implementation. So far, politicians and businesses in Europe are skeptical of OIS. However, because such a mechanism looks like the next “big thing” in Washington in the Sino-American rivalry, it may become a litmus test for transatlantic relations. Plus, Europeans have an interest in demonstrating that Biden’s cooperative approach yields more results than his predecessor’s unilateralism. There are also real long-term risks for Europe in not addressing Beijing’s dual-circulation strategy of strengthening its domestic market. China pursues its geopolitical goals of tying Europe into its supply chains and replacing European companies or making them more Chinese. The 2021 critical information infrastructure regulation, for instance, rendered European telecom equipment and service providers subject to national security reviews. This led to European firms localizing their production and research. Companies should better prepare for a mechanism to redirect investments in critical sectors.

Executive Summary The new German government pushes to digitize and green the G7 economies Holding the G7 presidency in 2022, Germany is responsible for setting the Group’s agenda, leading negotiations, and hosting the annual Leaders’ Summit at Schloss Elmau in Bavaria on June 26-28. Berlin aims to green and digitize the G7’s financial policy, such as through new financial technology regulations and a ‘climate club’ to align investment flows with climate goals. After 16 years with former chancellor Angela Merkel as a G7 fixture, the presidency is a key opportunity for the new German government to demonstrate its future policy direction to international partners State of Play 2022: A year of new challenges for the G7 Representing over 40% of the world’s GDP, the G7 still plays a key role in an increasingly complex global financial system. In addition to the immediate economic challenges posed by the COVID-19-induced downturn, G7 members are facing a series of financial challenges, such as heightened global inflation rates and unstable financial markets. At the same time, Russia’s aggressive actions on the border of Ukraine have put financial sanctions back on the agenda – including the potential exclusion of Russia from the SWIFT payment system. Furthermore, the recent proliferation of innovative financial technologies, including but not limited to cryptocurrencies, is bringing new regulatory and monetary questions to the fore. Finally, the G7 has come under increasing pressure to leverage financial policy to address climate change, particularly in the wake of recent extreme weather events like the 2021 floods in Western Europe. All these financial policy challenges reinforce the G7’s role as a forum for international financial cooperation and the importance of G7 members working together to address these challenges. Key Issues A new German government is setting the agenda In January 2022, Germany assumed the G7 presidency, shortly after the formation of a new government marked the end of the Merkel era. Chancellor Olaf Scholz of the center-left Social Democratic Party (SPD) and Finance Minister Christian Lindner of the pro-business Free Democratic Party (FDP) will be leading the G7’s financial policy negotiations. While this unprecedented coalition of SPD, FDP, and the Greens will aim to bring a new direction also to the G7, Scholz's previous role as Merkel's finance minister and vice-chancellor makes for at least some continuity. Indeed, a significant portion of Germany’s agenda will be consistent with the G7’s traditional approach to financial policy. This will include discussing ways to strengthen the international financial system, which is particularly important in the context of the global economic recovery. Given Minister Lindner’s belief in fiscal prudence, he will likely steer conversations to managing inflation rates through coordinated financial efforts. The agenda is likely to build also on previous G7 debt relief efforts in cooperation with the IMF to ensure developing countries have access to the resources they need to rebuild their post-pandemic economies. Finally, it is to be expected that Germany will want to discuss protecting market integrity from financial crimes through comprehensive cross-border efforts and law enforcement. Current events will also shape the agenda with Russia’s threat of war with Ukraine driving the debate on financial sanctions. When Russia invaded Crimea in 2014, the group suspended Russia’s membership of the then-G8 and coordinated financial sanctions vis-à-vis Moscow. The same situation may play out again in 2022 with the G7 cutting Russian financial institutions off from global transactions and, in a new move, imposing an embargo on US-made or US-designed technology used in defense and consumer industries. The G7: a more digital and green approach to financial policy Beyond focusing on the more traditional aspects of financial policy, the German priorities demonstrate the intention to accelerate the trend within the G7 to digitize and green financial policy. Driven by the finance minister’s free-market spirits, Berlin will try to leverage the digital economies of the G7 to create sustainable growth. In parallel, and to ensure that rules keep pace with the digital economy’s evolutions, the G7 will likely focus on addressing the regulatory challenges posed by the rise of innovative financial technologies. For example, crypto assets are gaining in popularity but are often anonymous, making it difficult for regulators to trace and identify international illicit transactions. They can also create financial instability by reducing central banks’ ability to effectively manage monetary policy. The global nature of crypto assets, in turn, requires international cooperation, particularly to tackle data gaps, monitor transactions, and create international rules when for central banks issuing digital currencies. Greening the financial system to achieve global climate goals is also a priority for Germany. It wants to create a climate club of like-minded countries to achieve carbon net-zero while ensuring their industries’ competitiveness is not disadvantaged. Inspired by the G7’s successful introduction of a 15% global minimum corporate tax which now includes 136 signatories, Berlin’s strategy is to first work with European and G7 partners to then bring the G20 on board. Specific goals are to implement similar domestic prices for carbon emissions, develop global standards to measure the CO2 content of products and materials, transform industries to be climate neutral, prevent carbon leakage in accordance with the EU’s Carbon Border Adjustment Mechanism, and create a global green hydrogen supply chain.

Executive Summary Flagship space programs will improve Europe’s global standard-setting capability The US is weighing the benefits of outbound investment screening (OIS) to counter China. Introducing de facto capital controls requires Europe’s support, putting the transatlantic relations to a test. The goal of OIS is “soft decoupling” to prevent the offshoring of increasingly discrete supply chains in aerospace, semiconductors, AI, IT, robotics, and other critical tech sectors to non-allied third countries. The EU has focused on space-based capabilities mainly to enable stronger continental defense and now faces the challenge of integrating discrete projects across member states and institutions State of Play Different dimensions of competition in outer space The idea of introducing a – US-only if needed, but preferably transatlantic – outbound investment screening (OIS) is gathering steam. This mechanism aims to screen and, eventually, ban certain US and European investments into critical tech sectors in non-allied third countries. The implicit goal is to prevent China from acquiring critical technologies through political pressure and, effectively, capital controls. Yet, capital controls increase economic costs and risks for American and European companies – from compliance burdens and higher risk premiums to a loss in strategic competitiveness. Washington’s actions are guided by geopolitical, not commercial, reasoning. The Biden administration is likely going to make it a central request to Europeans in confronting China. Many European countries are skeptical, but prioritize a strong transatlantic partnership. Furthermore, EU governments see increasing risks in being tied to Beijing-controlled tech supply chains. Key Issues A race for technology and regulation Rivalries among states competing for power on Earth have not precluded space cooperation. The most prominent cooperative effort, the International Space Station (ISS), connects two historic competitors, the United States and Russia, with Canada, Japan, and the European Space Agency (ESA) in pursuit of ground-breaking science. However, states are becoming more proficient space actors as innovation reduces barriers to space access. Reusable launch vehicles, improved satellite manufacturing, and revolutionary operational constructs have lowered the costs to access space. These technological innovations have flattened states’ comparative advantages, allowing them to choose ideologically close partners instead of having to collaborate with political opponents that command a specific technology needed. States still compete for technological superiority, but the major contest among leading states has evolved into a sprint to attract a critical mass of partners to establish a preferred spatial order. For instance, the United States has invited all nations to sign the Artemis Accords, a set of obligations based on Washington’s interpretation of existing international law. Furthermore, the U.S. Department of Defense recently issued internal guidelines for space behavior. These tenets could be an attempt to seed a future universal regulatory framework for space. China, too, is aiming to influence the rules in space by establishing ties with countries in Asia, Africa, and Europe through its Belt and Road Initiative (BRI). The space-related aspects of BRI focus on constructing space and ground segments, integrating services, and guaranteeing coordinated policies for future collaboration. China is expected to eventually leverage these relationships for support of its preferred governance methods and practices. Europe’s continued challenges in space despite a new strategy The EU has pivoted from considering space as a scientific pursuit to seeing it as an enabler of strategic sovereignty. The aim is to ensure the bloc can credibly and independently operate in and through space without relying on foreign systems. European programs like CHEOPS for planetary discovery and Rosetta for comet inspection already indicate scientific mastery, while launch vehicles like Ariane 5 evidence a strong industrial base. Adopting civil systems into security missions allows the EU to leverage this expertise to support strategic autonomy. For example, the EU has incorporated civilian systems for Earth observation (Copernicus) and global satellite navigation (Galileo) into its security network to support force readiness and lethality. These arrangements not only lower Europe’s dependence on foreign systems, but also support the EU’s strategic autonomy by bolstering security and economic prosperity. The European Defence Agency has prioritized developing space-based and -related capabilities to both protect space assets and reinforce long-term technological sovereignty. Major focus areas relate to deriving information superiority from space by leveraging Positioning, Navigation and Timing (PNT), tactical Communication and Information Systems (CIS), Intelligence, Surveillance and Reconnaissance (ISR), and Space Situational Awareness (SSA), among others. This process started with establishing EU-wide defense requirements. Now the challenge is to integrate discrete projects across states and institutions – a task assigned to the European Commission’s Directorate General for Defence Industry and Space. Europe faces several challenges in space. European countries and the EU itself have traditionally been junior partners in bigger missions and now struggle to initiate novel flagship programs. Tying ambitious projects in space to other strategic goals like shaping Europe’s digital future as well as reaching the EU’s climate goals could galvanize political will and open new funding streams. Moreover, tangible European assets in orbit would improve the continent’s standards-setting capability, which will be a critical aspect in efforts to systematize space traffic coordination and other much-needed orbital regulations.

Executive Summary Balancing domestic and international energy transition concerns A timely and successful green energy transition is critical for MENA countries as the region enjoys an abundance of hydrocarbon sources but is also a “hotspot” for climate-related risks and extreme events. The countries’ adoption of ‘green-ish’ nuclear energy presents an opportunity for non-Western suppliers of large and small modular reactors, resulting in increased Russian and Chinese influence. While regional leaders are reluctant to implement long-term initiatives as they bet on lower commitment to climate action from future US administrations, intra-GCC competition may add impetus to act. State of Play Short-term commitments to the green energy transition Few regions in the world have more at stake than the Middle East and North Africa (MENA) when it comes to the green energy transition. The region’s hydrocarbon abundance made Gulf countries rely on oil and gas exports for more than 80 per cent of government revenue, while exposure to climate-related risks and extreme events has increased water scarcity and desertification. Yet, it will be difficult for the region’s oil producing countries to diversify their economies, partially due to concerns about social and political stability and partly because past financial and economic reform efforts did not create alternative productive sectors. Given the US’ influence in the region, the Biden Administration’s emphasis on climate action has led several MENA countries to set net zero goals and introduce respective initiatives. The EU’s leverage, in contrast, is more moderate, especially in Gulf Cooperation Council (GCC) countries. Still, the ability of regional governments to continue delivering public goods at lowered prices for citizens will clash with the climate change agenda sooner or later, potentially leading to a revision of current commitments. Key Issues The energy transition drives nuclear energy adoption and local clean energy projects Efforts to combat climate change and accelerate the energy transition in the MENA region are lagging Western countries’ endeavors. The lack of urgency to act on the part of oil producing countries can be attributed to continued demand for the region’s fossil fuels from Asia for the foreseeable future. Furthermore, regional leaders recognize a significant gap between the ideals and realities of the global climate change agenda, which in turn reduces the incentives to enact change domestically. With regard to the energy transition, MENA’s non-oil producing countries face the challenge of limited access to finance and poor energy infrastructure. At face value, the regional reaction to the recently concluded United Nations climate conference, COP26, was positive, but participation was primarily viewed as a political and diplomatic necessity. Climate advocates have accused regional heavyweights, such as Saudi Arabia, of having worked with lobbyists ahead of the Glasgow gathering to water down the conference’s outcomes. Since most MENA countries will struggle to simultaneously meet emission targets and energy demand, a renewed drive to explore nuclear energy and the attempt to rebrand it as a green alternative to the hydrocarbon sector is likely. The first of the UAE’s four South Korean-built reactors is also the first to come online in the region and the remaining three will be completed in the next two years. Egypt is already in contract with Russia to build four reactors while the race is on to meet Saudi Arabia’s stated interest. The possible shift to nuclear energy does not bode well for Western nuclear power plant manufacturers as Asian and Russian manufacturers currently dominate the market. One exception may be small modular reactors below a capacity of 1000MW in which Western manufacturers can still compete. With a view to the energy transition, the GCC states, especially Saudi Arabia and the UAE, will present the most interesting opportunities for investors. These countries will likely focus on leveraging existing technologies in carbon capture and storage while also seeking to develop several clean energy products from natural gas to solar power as well as blue and green hydrogen production (designating the low-carbon or carbon-neutral making of the stuff, respectively). Efforts to increase electrification of GCC economies (i.e., replacing fossil fuel-based technologies with those using electricity as a source of energy) and offsets in green initiatives (like tree planting to capture carbon) constitute other attractive opportunities for international businesses. For instance, Saudi Arabia plans to create hundreds of man-made lakes to capture seasonal rains or draw seawater inland. Further climate action impeded by uncertainty about lasting US commitment While regional leaders recognize the importance of tackling climate change and the global push for climate action, they question whether environmental policies will remain a priority of future US administrations. This still being the most important benchmark, critics view current measures in the region mainly as lip service to gain goodwill with Washington. MENA countries will likely continue with highly aspirational commitments, such as Saudi Arabia’s Vision 2030 plan to increase the share of renewable energy production to 50% from today’s 1%, or pledges that disguise details, such as Riyadh’s unsubstantiated net-zero claim that excludes oil exports. In contrast, observers view Egypt’s commitment to increase its share of renewable energy from 20% today to 40% in the next fifteen years as more reasonable. Intra-GCC competition may actually add impetus for Gulf countries to take climate change seriously and position themselves as leaders in this space. Further action by China and India, the region’s primary energy resource consumers, could also drive the region’s green energy transition – not least because of China’s dominance of the nuclear reactor market. While European businesses could stand to benefit from the GCC’s energy transition, the EU is expected to be more relevant in the Levant and North Africa. There, it can actively foster the green energy transition through its numerous financing mechanisms, especially as Algerian, Egyptian, and East Mediterranean gas are critical for Europe’s energy security.