NICHOLAS SHUBITZ: A shared Brics reserve currency has benefits but many risks

The formation of a joint Brics reserve currency has recently been touted as a means of accelerating de-dollarisation within Brics. A joint currency for trade settlement could lessen exchange rate volatility, ease fiscal and monetary policy constraints and improve trade flows among the member countries. But the initiative comes with a number of political and economic risks.

First, the national debt of Brics countries is considered too high risk to underpin global currency reserves. By contrast, the current major global reserve currencies all offer low bond yields compared with Brics country debt. But recent geopolitical events have called the stability and usefulness of these currencies into question. The risk of sanctions is increasingly prevalent, while inflation in the US, EU and UK are at multi-decade highs, suggesting that central banks in these countries have failed in their mandate to ensure price stability.

The Brics bloc reportedly makes up 40% of the world’s population but only 25% of global GDP and 16% of global trade, suggesting that a Brics currency could serve as a driver of increased trade flows between the participating countries. That said, in terms of GDP at purchasing power parity, Brics already accounts for almost 40% of the global total, which shows that, in reality, the Brics economies are already well developed but simply undervalued in dollar terms.

It is also counterintuitive that global reserve currencies should be issued by countries that maintain large budget and trade deficits, while Brics economies often achieve large trade and budget surpluses. Additionally, default risk is further moderated by the use of a joint currency due to the positive effects of diversification. This is exemplified by the fact that the New Development Bank (NDB) has a higher credit rating than any individual Brics country.

The experience of the euro provides valuable insight into the creation of a joint currency. The Brics currency could be developed for use in trade settlements without replacing any Brics national currencies as domestic legal tender. This would emulate the benefits of the euro as a mechanism for trade liberalisation while avoiding many of the shortfalls of the single currency, such as constrained monetary and fiscal policy autonomy and the inability of participating countries to see competitive devaluation.

The currency could be backed by a basket of Brics currencies, which could be extended to include additional currencies and commodities in future. Unlike a currency backed by gold, the Brics currency would not have deflationary or inflationary economic effects arising from the variable supply of a single underlying commodity. Issuance would be proportional to the accumulation of component currency reserves. These currency reserves could be developed through trade settlements conducted between participating countries.

Russia

Russia’s gas-for-roubles scheme serves as a template for such a mechanism, where euros are exchanged for roubles by Gazprombank. But in this case payment could be made in any Brics national currency before being converted into an equally weighted basket of rupees, roubles, real, renminbi and rand, and held as reserves by the trade settlement intermediary that acts as the issuer of the Brics currency.

Such a currency offers multiple benefits. It increases demand for Brics countries’ national currencies and prevents any individual Brics country’s currency from becoming singularly dominant in global trade. This is important as increased adoption of the yuan, for example, would have negative implications for China’s balance of trade. A joint Brics currency thus resolves many of the issues surrounding de-dollarisation with regard to asymmetrical trade relationships within Brics.               

A joint Brics currency reduces exchange rate risk for both sides of the transaction while reducing dependence on other foreign currencies. This is important as the current global reserve currencies are issued by countries that often seek to sanction or contain the rise of individual Brics countries and have increasingly abused the status of their currencies via quantitative easing and negative real interest rates.

Creating a joint Brics currency based on trade flows between Brics countries could enable the development of a new global reserve currency, providing the Brics nations with much-needed financial autonomy. This will ultimately strengthen Brics national currencies, lower Brics government debt servicing costs and raise capital for infrastructure financing as the underlying Brics currency reserves could eventually be loaned out at a favourable interest rate within a fractional reserve banking system.

While the idea of a joint Brics currency certainly has merit, de-dollarisation processes have thus far been predominantly bilateral rather than multilateral as there are country specific issues related to the adoption of a joint currency.

Nevertheless, as currency localisation and de-dollarisation remains a stated policy aim that is already being accelerated within Brics, the formation of a joint currency could prove a worthwhile development with the potential to resolve several issues for Brics countries within the dollar-based global financial system.

SA faces several disadvantages within the dollar-dominated global financial system, including domestic currency weakness and volatility, high levels of externally generated inflation, and high debt servicing costs. Consequently, SA may benefit from the use of a joint Brics currency.

The US is exporting inflation around the world. Large stimulus cheques and loose monetary policy during the coronavirus pandemic has created excessive consumptive demand in the US, driving up prices of globally traded goods and commodities. The US Federal Reserve has subsequently begun raising rates to tame inflation and the US dollar has appreciated, creating further inflationary pressures in emerging markets due to the declining buying power of our currencies relative to the US dollar.

During the pandemic the Fed implemented quantitative easing (QE) for the second time since the 2008 financial crisis. QE has consequently seen the Fed’s balance sheet expand from less than $1-trillion to more than $8-trillion. By contrast, and despite domestic political pressures, the SA Reserve Bank has maintained that QE is not an appropriate tool for SA, citing the risk of a “moral hazard”.

The rand declined from about R8/$1 in June 2008 to over R16/$1 in June 2022 even though the central bank maintained higher real interest rates than the Fed during this period, indicating that policy interventions by the Bank to stabilise the rand are relatively ineffectual in the context of a US dollar-dominated global financial system.

As a net importer of oil, a weak local currency is a strong driver of inflation, which invariably leads to higher interest rates, making infrastructure spending more costly. To make matters worse, additional default risk premiums are priced into rand-denominated debt over and above the inflation premium, even though SA has a lower debt-to-GDP ratio than the US, along with the rest of the G7 with the exception of Canada and Germany.

While the development of a joint Brics currency has many potential benefits, the prospects of such an initiative are currently uncertain as each member state within Brics has different economic and political concerns, which create divergences in their respective enthusiasm for undertaking such a project. Nevertheless, all the Brics countries have shown an interest in the idea as part of an established and ongoing de-dollarisation process.

Russia is particularly motivated towards exploring all avenues of de-dollarisation due to its geopolitical confrontation with the US and its exclusion from the dollar-based global financial system. A joint Brics currency appeals to Russia as interventions to alleviate the effects of economic sanctions (such as capital controls and the gas-for-roubless scheme) have led to an over-appreciation of the rouble, which presents its own economic risks to the country such as a loss of export competitiveness and a budget deficit in rouble terms despite an expanded dollar-denominated trade surplus.

US trade benefits

By contrast, the other Brics countries are still heavily reliant on trade and investment from the US and do not wish to risk these capital flows. This is particularly true for Brazil, India and SA, which all enjoy a better balance of trade with the US than with their Brics counterparts.

China has many reasons for pursuing de-dollarisation and has already undertaken many initiatives towards this objective. However, China, like other Brics countries, values its trade relationship with the US, which is still China’s largest export market, and does not wish for de-dollarisation to become a reason for conflict escalation with the US.

While many forms of de-dollarisation, including the internationalisation of the yuan and alternative payment mechanisms, have already been established and remain more likely to be expanded on in the short-term, a joint currency holds certain benefits for China. A joint currency would help prevent the yuan from becoming overvalued on a trade weighted basis if the yuan replaced the dollar in China’s international trade. And while India sees China as a major geopolitical rival, China is far more concerned with the increasingly aggressive anti-China foreign policy of the US. Heightened tensions surrounding Taiwan are likely to accelerate China’s de-dollarisation initiatives and the Russian experience serves as severe warning in this regard.

SA, while sharing some of the structural concerns of India and Brazil, faces the constant risk of external economic shocks within a dollar-dominated financial system, and should be willing to consider the formulation of Brics alternatives. While SA is unlikely to de-dollarise completely, a Brics currency for trade settlement between Brics countries could certainly prove beneficial in the long run.

• Shubitz is an independent researcher. This article is based on a paper developed in collaboration with a group of international students at Fudan University, Shanghai.