So far, the BRICS summit has mostly been a vast political stunt show, not unlike other meetings where international political figures shake hands and rub elbows. However, that should not lead anyone to believe that BRICS is not moving forward as a credible economic sphere with gradually growing independence of Europe and North America.
On the contrary, all signs point to a continuation of de-dollarization initiatives that began more than a decade ago. These initiatives are paying off, with the BRICS group growing in popularity. According to Al Jazeera, there are some 40 countries aspiring to join the group,
with 23 having submitted their applications. Some of the countries aspiring to be BRICS members include Argentina, Bangladesh, Bahrain, Cuba, Ethiopia, Indonesia, Iran, Nigeria and Saudi Arabia.
There is an apparent reason for the BRICS group’s popularity. In another article, Al Jazeera explains how the structure of existing global financial institutions is seen from a non-Western viewpoint:
In nominal terms, the BRICS countries are responsible for 26 percent of the global GDP. Despite this, they get only 15 percent of the voting power at the International Monetary Fund (IMF).
Technically, the point made here is moot. The voting rules at the IMF are not based on the relative size of a member country’s GDP. They are based on so-called special drawing rights, effectively an intra-IMF currency system that balances a member state’s contributions against its influence over the organization. Nevertheless, it illustrates how political leaders in non-Western countries can see institutions like the IMF as Western-centric.
However, the main motivation for more countries to join BRICS is not the cultural aspect of allegedly or actually being marginalized by the West. The real driver here is a combination of economic growth and a desire to shield one’s own country from the wrath of dollar-attached sanctions, should one’s domestic policies happen to displease the American government.
Theoretically, the ideal shield against unwanted U.S. influence would be to detach a nation’s own currency, trade, and central-bank reserve portfolio from the dollar. The first step is easily taken by the central bank not pegging the currency against the dollar, i.e., by not having a fixed exchange rate against the greenback.
The second step, to shift trade off the dollar, is tied to the third: a central bank typically holds in reserves the currencies that are most frequently used as payments for exports and imports. But that relationship also works the other way: if a central bank holds large reserves of a certain currency, this makes it easier for exporters and importers to clear transactions in that currency.
It is here that the BRICS group can find its leverage in reducing the role of the dollar in their trade and central-bank reserves. This work has already started: in 2012 they launched a project that in 2014 became the Contingency Reserve Agreement, CRA. Its purpose is to provide a credit line that allows participating central banks to stabilize currency fluctuations without risking depletion of their currency reserves.
It is an exaggeration to refer to the CRA as an alternative to the International Monetary Fund, but that may very well change in coming years. The system is evolving: since its founding, the BRICS countries have effectively been test-running it in order to establish its institutional credibility. In a statement on August 22nd, the South African Reserve Bank referred to the sixth test run of the CRA, which resulted in
amendments to the Inter-Central Bank Agreement to improve the operational readiness and credibility of the CRA mechanism
The Inter-Central Bank Agreement is a regulatory mechanism that “lays down the procedures and obligations to be observed by the central banks under Brics.” In addition, it regulates how participating countries can contribute to the funding of the CRA, as well as draw on their credit lines with the system.
It is important to note that the CRA itself is not a de-dollarization mechanism. It actually operates based on the dollar. At its founding, the five original BRICS countries pitched in a total of $100 billion, with China contributing 41%. The use of the U.S. currency limits the purpose of the CRA to helping participating central banks stabilize their currencies and their current accounts—transactions across their borders—by relying partly or entirely on the CRA system.
It takes a lot of institutional experience to make a system like this work. One of the main lessons to be learned is to what extent the system can help the participating central banks avoid exchange-rate destabilization. Once the institution has built its know-how and found the right balance in its funding, operations, and lending, it can expand its currency stabilization operations—primarily so-called currency swaps—and eventually replace the dollar with another reserve currency.
This replacement can happen within the CRA or through another system, built upon the experiences of the CRA.
As an educational tool and test pilot for a formal, fixed, and perhaps gold-based exchange-rate mechanism, the CRA is a good idea. It does not operate based on fixed exchange rates between participating countries, which gives their central banks, as well as the lending institution itself, the ability to stabilize currencies and exchange rates without the market stress that comes with fixed exchange rates. If a depreciating currency is appreciated by means of CRA help, the system is successful if the appreciation happens, regardless of whether it returns the exchange rate to its original value.
A flexible exchange-rate system allows for the creation and solidification of the system without the stringencies required to maintain fixed rates. Again, central banks can approximate exchange-rate stabilizing operations; the CRA system can learn to function in a timely fashion to test the boundaries of its financing prowess, etc.
Thanks in part to the CRA, the BRICS community is approaching the point where it can leap into a formal exchange-rate mechanism—and, at the same time, move intra-group trade entirely off the dollar. This ambition is no secret: back in April, India Times cited Alexander Babakov, deputy chairman of the Russian parliament, as saying that “countries are working on creating a new form of currency with a plan to present its development at the BRICS leaders’ summit this year”. While no such system has been announced yet, it would be logical for the participating nations to deliver a progress report in Johannesburg.
As an indicator of their ambitions in this direction, last year, the Chinese central bank established the Renminbi Liquidity Arrangement with the Bank for International Settlements. Notably, on August 22nd, the same day as the BRICS summit opened, China Daily reported that the Chinese currency has taken another step out in the world of global finance:
Starting from June 19, a total of 24 Hong Kong-listed companies, accounting for 40 percent of the average daily turnover of the [Hong Kong] cash equities market, were included in the new dual counter model. These stocks can thus be traded and settled both in Yuan and Hong Kong dollars, while only the latter were accepted before this new arrangement.
Yuan is formally the domestic account unit for the renminbi; in practice, the Chinese have historically operated with parallel currencies as part of an elaborate financial-regulation scheme.
The article by the China Daily is of course politically well timed. Just as the BRICS summit takes place in South Africa, it explains how the Chinese currency can become a credible base for stock-market trade in other countries, beyond Hong Kong. This means that investors from one BRICS country can invest in the stock market of another country, and they make all payments in renminbi. Likewise, they can receive payments in renminbi as they sell the stocks.
For anyone aspiring to de-dollarize the global economy, this is a big step forward. Daily financial transactions are vastly bigger than transactions paying for the trade in goods and services. This means that when central banks need to intervene to stabilize the exchange rates of their currencies, it is often because of fluctuations in international financial transactions. One source of such fluctuations is the stock market.
If a country’s stock market is already operating with a dual counter model, with the local currency and the renminbi as parallel means of payment, then the central bank is less at risk of having to counter short-term currency destabilization. If a foreign investor gets paid in renminbi (and not the local currency) he can simply transfer that renminbi directly to his home country and deal with the exchange-rate situation there.
Furthermore, this dual counter model encourages the central bank to increase its renminbi currency reserves—and correspondingly reduce its holdings of U.S. dollars. Participation in the Renminbi Liquidity Arrangement, known by its acronym RMBLA, is logical in conjunction with the opening-up of stock markets for the Chinese currency; as the Indonesian central bank explained when it announced its participation in the RMBLA,
Each participating central bank will contribute a minimum of [renminbi] RMB 15 billion or US dollar equivalent, in RMB or US dollar, placed with the BIS, creating a reserve pool.
Unlike the dollar-based CRA system, the RMBLA uses the renminbi as its default currency. This means that all transactions between the liquidity reserve and participating central banks will either be in renminbi, or in dollars but with the amount pegged to the renminbi. This means that if a central bank borrows U.S. dollars from the system, and the dollar depreciates vs. the renminbi before the loan is paid back, that central bank will have to pay more just to pay back its loan.
If, on the other hand, they take out the loan in renminbi in the first place, they run no such exchange-rate risk.
The rise of the Chinese currency comes as no surprise to Asian analysts. In an August 2nd paper from the Institute of Chinese Studies in Delhi, India, presented a list of reasons why the renminbi is gaining prominence in Asia. While some of the discussion is chatty, it gives a good ‘local’ perspective on the rising strength of the Chinese currency. It is interesting to note that many countries in Asia are aspiring to become BRICS members.
It remains to be seen exactly what steps the BRICS group will take in the coming year, but it would be surprising if they did not amend their CRA and RMBLA institutions with a system for fixed exchange rates. If they take that step, they will also have to align these two systems, and to increase the liquidity available to participating countries. The more trade and financial transactions that rely on the renminbi, and not the dollar, the more of the Chinese currency will be needed as reserves with participating central banks.
With all this in mind, the BRICS countries have formidable challenges to overcome before they can claim de-dollarization victory. One big question for them is if the Chinese central bank is willing to increase the supply of its currency to meet growing global demand. China already has a problem with over-liquidity in its financial system; unless the central bank performs a delicate balancing act with reducing liquidity domestically and increasing it internationally, they may risk a monetarily driven inflation spike at home.
Last but not least, it is difficult to see how the Chinese could expand the global role of their currency and still maintain their current, formal dual-currency system with the renminbi and the renminbi. This system has historically been used by the Chinese government to get around market-driven currency appreciations that often hit heavily export-dependent economies. It has also been used to heavily regulate financial transactions across China’s borders.
Is the Chinese government willing to let go of all of this in order to dethrone the dollar as the preeminent global reserve currency?
