The 14th summit of Brics countries – Brazil, Russia, India, China and South Africa – has made clear that the possible creation of a common currency is still an illusion for now. A common currency would in theory enable Brics countries to move from bilateral to multilateral clearing in trade settlement and reduce their dependence on the dollar.
A declaration released at the gathering in Johannesburg on 24 August made no mention of a common currency and instead focused on bilateral clearing – the second-best option. It stressed the importance of ‘encouraging the use of local currencies in international trade and financial transactions between Brics as well as between their trading partners.’
It also encouraged the ‘strengthening of correspondent banking networks between the Brics countries and enabling settlements in local currencies.’ This ignores efforts by the Financial Stability Board to replace outdated correspondent banking with new forms of cross-border settlement, including central bank digital currencies.
There are some inherent problems in bilateral trade settlement. As long as trade is balanced between countries, such a model is no problem. However, when trade imbalances occur, two kinds of perennial problems arise. The first is the conversion into a commonly accepted currency, most likely the renminbi. Second, surplus funds from bilateral trades have to be held and invested in this local currency.
Conversion of local currency surpluses is the flipside of providing credit to those running deficits. There will have to be a paymaster who will provide a commonly accepted currency. China is the obvious candidate for this role but has not gone beyond a vague support for the internationalisation of the renminbi.
Recent examples have shown that this conversion will be the main problem for operating Brics trade settlement in local currencies. Sergey Lavrov, Russian foreign minister, complained that Russian exporters of oil are sitting on a pile of Indian rupees. India had no other choice than to pay Russia in renminbi. Russia reportedly changed these into dollars in the offshore renminbi market, thus contributing to the recent depreciation of renminbi.
The reverse side is providing the key currency against local currencies. This is done through China’s bilateral swap agreements, concluded with some 40 countries and Chinese bank lending. These swap agreements have been activated, notably with Pakistan, Argentina, Russia and Turkey. The People’s Bank of China provides renminbi while accepting weak depreciating currencies. China is taking on the role of the International Monetary Fund, which has traditionally provided universally accepted currencies in return for weak local currencies. China thus becomes the lender of last resort.
With more countries running into payments difficulties, China has now provided close to $240bn in liquidity support for countries in distress through swaps and bank lending. If China wants to become Brics paymaster, more swap arrangements have to be activated or rolled over.
Finally, receiving local currencies from trade, swap transactions or credit will need to be added to the foreign exchange reserves of countries. While renminbi may be added under IMF rules as it is in the special drawing rights basket, other Brics currencies might not be accepted as reserves in the current IMF definition, which only includes reserves in the five SDR currencies, plus the Australian and Canadian dollars and the Swiss franc.
The sixth edition of the IMF’s ‘Balance of Payments and International Investment Position Manual‘ states that ‘reserve assets are those external assets that are readily available to and controlled by monetary authorities for meeting balance of payments financing needs, for interventions in exchange markets to affect the currency exchange rate and for other related purposes’. The phase ‘readily available’ will have to be freshly assessed.
Although the summit declaration states that Brics countries ‘support a robust global financial safety net with a quota-based and adequately resourced IMF at its centre’, we have seen the role of the IMF challenged on many fronts in the new fragmented global economy.
Herbert Poenisch is Senior Fellow, Zhejiang University, and former Senior Economist, Bank for International Settlements.