At the last BRICS summit held in March in New Delhi, development banks of the participating
countries agreed on a proposal to extend credit in local currency for trade, project financing and
So far, no clear mechanism on how they will extend local currency credit has been announced.
Some financial gurus even dismiss the BRICS agreement as purely symbolic. Yet banks in London,
New York, Tokyo and Singapore would be wise to take a second look at what now could be the
most significant agreement in international finance since the euro.
BRICS countries make up a massive trade bloc. Current intra-BRICS trade stands at $307 billion; it
is set to reach $500 billion by 2015. Within BRICS, China is the dominant country, exporting $135
billion in goods and services a year to its partners. India imports $50 billion annually from China and
Chinese goods account for 11.8% of India’s total imports, increasing their share of the Indian market
by 2% in just four years.
As trade increases, China could move swiftly to provide renminbi for importers of Chinese goods.
At this time, China facilitates payment in renminbi through a central bank liquidity swap. Since 2009,
16 countries have exchanged local currencies for a total of 1.6 trillion renminbi; more are in line to
participate-Japan and Great Britain are rumored to be in queue. But after the Delhi meeting, China’s
BRICS partners may leapfrog and be next on the list.
From BRICS, Russia is currently the only country that swaps its currency with China-India, Brazil,
and South Africa should take note.
Four factors make a central bank liquidity swap particularly important. First, BRICS countries are
losing purchasing power because of depreciation against the dollar.
The dollar accounts for 40% of global foreign exchange trade. But it’s getting harder for BRICS to
buy dollars. Brazil has seen its currency depreciate by over 16% since February 2012 and the
Indian rupee fell to an all-time low of 56.51 to the dollar on Thursday, losing more than 20% of its
value in the last 12 months. India is paying more for dollars than it has done in over a decade.
Second, following the 2008 financial crisis, rupee-dollar exchange rate volatility has increased by as
much as 50%, making it difficult to predict the cost of dollars.
This uncertainty places India in a tough situation, given rising prices for key commodities such as
crude oil, a slowdown in capital inflows and a current account deficit now at a decadal high of 4% of
gross domestic product (GDP). India isn’t alone-Brazil and South Africa face the same problem as
their currencies have seen deviations of 25% to the dollar. Their current account deficits too are
high, at -2.1% and -3.4% of gross domestic product, respectively.
Third, there is an opportunity to save on transaction costs, which can cost Indian business up to 1-
2% of a deal. Vladimir Dmitriev, chair of the Russian development bank, suggested in the BRICS
summit agenda that countries will save up to 4% by entering into these agreements, saving on
transaction costs, financing fees and currency fluctuations. Quick math shows that at full potential,
BRICS countries save $12.3 billion a year in banking services. India could save a whopping $2.3
Lastly, a central bank liquidity swap will benefit small business. With the credit rating agencies such
as S&P downgrading India, small- and mid-cap companies are struggling to get dollar loans at
reasonable interest rates. Drawing on a swap line from China, the Reserve Bank of India (RBI) can
offer attractive loans to businesses through the Export-Import Bank in renminbi to finance Chinese
deals without having to worry about inadequate dollar supply.
There is geopolitical risk in this, however.
In the late 1950s, India entered into a similar currency agreement with the former Soviet Union
largely for arms deals. But India ran up a trade deficit and from 1955-76, Russia accumulated
upwards of $350 million in non-convertible rupees.
As a result, Russia sought a strategic advantage from its poorer trading partner. India’s signature
commodities such as tea were re-exported by Russia to Western markets, shrinking India’s market
share with key trading partners. Moscow even petitioned for naval base rights. Prime minister Indira
Gandhi refused, believing that the quid pro quo would threaten regional security.
As with the Soviet Union then, so is the possibility with China now; India’s trade deficit with China is
estimated to reach $60 billion by 2014-15.
In negotiating its rupee relationship with Russia, H.V.R. Iyengar, governor of RBI (1957-62), wrote to
prime minister Jawaharlal Nehru warning him of the dangers of such currency arrangements. Nehru
ignored him, declaring that “political compulsions far outweigh economic considerations”.
India’s motives now are economic. BRICS swaps save money on imports by freeing India from
currency fluctuations and reducing the cost of funds. The key for India will be to negotiate favorable
terms of agreement. Only then will India’s economic advantages outweigh the geopolitical risks of
such a deal.
Samir N. Kapadia is researcher, geopolitical studies, at Gateway House: Indian Council on
Note from the author -
Brazil, India, Russia, and S. Africa will swap for renminbi because of the sheer quantity of imports -
they'll buy $134 billion in goods from China this year. So far, 16 other countries have done a
currency swap with China. After the summit meeting, the signal for us is that Brazil, India, and
South Africa will be next.
With depreciating currencies, volatility, high interest rates from foreign banks, and an overall tough
market environment, BRICS swaps seem very likely in the near future.
The People’s Bank of China jolted the financial world in March with a proposal for a new global
monetary arrangement. The proposal initially attracted attention mostly for its signal of China’s rising
global economic power, but its content also has much to commend it.
A century ago almost all the world’s currencies were linked to gold and most of the rest to silver.
Currencies were readily interchangeable, gold anchored exchange rates and the physical supply of
gold stabilized the money supply over the long term.
The gold standard collapsed in the wake of World War I. Wartime financing with unbacked paper
currency led to widespread inflation. European nations tried to resume the gold standard in the
1920s, but the gold supply was insufficient and inelastic. A ferocious monetary squeeze and
competition across countries for limited gold reserves followed and contributed to the Great
Depression. After World War II, nations adopted the dollar-exchange standard. The U.S. dollar was
backed by gold at $35 per ounce, while the rest of the world’s currencies were backed by dollars.
The global money stock could expand through dollar reserves.
President Richard Nixon delinked the dollar from gold in 1971 (to offset the U.S.’s expansionary
monetary policies in the Vietnam era), and major currencies began to float against one another in
value. But most global trade and financial transactions remained dollar-denominated, as did most
foreign exchange reserves held by the world’s central banks. The exchange rates of many
currencies also remained tightly tied to the dollar.
This special role of the dollar in the international monetary system has contributed to the global
scale of the current crisis, which is rooted in a combination of overly expansionary monetary policies
by the Federal Reserve and lax financial regulations. Easy money fed an unprecedented surge in
bank credits, first in the U.S. and then elsewhere, as international banks funded themselves in the
U.S. money markets. As bank loans flowed into other economies, many foreign central banks
intervened to maintain currency stability with the dollar. The surge in the U.S. money supply was
thus matched by a surge in the money supplies of countries linked to the U.S. dollar. The result was
a temporary worldwide credit bubble, followed by a wave of loan defaults, falling housing prices,
banking losses and a dramatic tightening of bank lending.
China has now proposed that the world move to a more symmetrical monetary system, in which
nations peg their currencies to a representative basket of others rather than to the dollar alone. The
“special drawing rights” of the International Monetary Fund is such a basket of four currencies (the
dollar, pound, yen and euro), although the Chinese rightly suggest that it should be rebased to
reflect a broader range of them, including China’s yuan. U.S. monetary policy would accordingly
lose its excessive global influence over money supplies and credit conditions. On average, the
dollar should depreciate against Asian currencies to encourage more U.S. net exports to Asia. The
euro should probably strengthen against the dollar but weaken against Asian currencies.
The U.S. response to the Chinese proposal was revealing.Treasury Secretary Timothy Geithner
initially described himself as open to exploring the idea; his candor quickly caused the dollar to
weaken in value-which it needs to do for the good of the U.S. economy. That weakening, however,
led Geithner to reverse himself within minutes by underscoring that the U.S. dollar would remain the
world’s reserve currency for the foreseeable future.
Geithner’s first reaction was right. The Chinese proposal requires study but seems consistent with
the long-term shift to a more balanced world economy in which the U.S. plays a monetary role more
coequal with Europe and Asia. No change of global monetary system will happen abruptly, but the
changes ahead are not under the sole control of the U.S. We will probably move over time to a
world of greater monetary cooperation within Asia, a rising role for the Chinese yuan, and greater
symmetry in overall world monetary and financial relations.
ABOUT THE AUTHOR
Jeffrey D. Sachs is director of the Earth Institute at Columbia University
This article appeared in Scentific American.com.
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