BRICS and the New Financial Architecture
The BRICS summit held in October 2016 suggested the possible use of local currency in intra-BRICS trade to lower costs. This article extends this idea and proposes a scheme for setting up a clearing account in local currencies of the BRICS countries. It contends that such a step will provide avenues for generating additional demand within the region while cushioning the member countries against shocks from exchange rate volatility.
The initiatives taken by the member nations of BRICs (Brazil, Russia, India, China, and South Africa) to set up a new financial architecture at its eighth summit held in October 2016 in India have recently been under the spotlight. In order to avoid the International Monetary Fund (IMF) type of loan conditionalities and tackle the dominance of the United States (US) dollar in global finance, the new institutions set up by the BRICs are expected to provide a much needed change in the global financial architecture. These institutions include the New Development Bank (NDB), the BRICS-led Contingency Reserve Fund (CRF), and the Asian Infrastructure Investment Bank (AIIB).
At the summit, measures outlining the potential of these new institutions were announced. It is not an insignificant achievement that the NDB, which started its operations in July 2015 with an initial authorised capital of $100 billion, has already been disbursing loans, which include $300 million to Brazil, $81 million to China, $250 million to India, and $180 million to South Africa for renewable energy development projects (RT 2016).
On other fronts concerning trade, while the free trade area proposal from China was turned down by the other members of BRICS as they were concerned with their current trade deficits with the country (Hindu 2016), all agreed to reduce the prevailing non-tariff barriers (Mishra 2016). The BRICS nations also agreed to set up an independent credit rating agency “based on market-oriented principles,” with the aim to dilute the dominance of the three big US-based rating agencies—S&P, Fitch, and Moody’s. Often guided by the political concerns of the US, the ratings of these agencies have often constrained growth in emerging nations (PTI 2016).
The value of exports by the BRICS nations to each other has been rather small at $242.3 billion in 2015 as compared to their global exports to the rest of world, which stood at $3,150.9 billion during the same year (EXIM Bank 2016). Proposals were also made at the Goa Summit to expand intra-BRICS trade to $500 billion by 2020 (Mohan 2016).
A BRICS Clearing Account in Local Currency
An important idea which emerged at the summit was the possible use of local currency in the intra-BRICS trade which, as pointed out, would cut back the costs of trading by 6% or more (Mohan 2016). I consider this proposal of high significance not only for lowering costs but also because it could lead to trade and demand expansion within the member countries.
Extending the idea of the use of local currencies in trade, this article proposes a scheme for setting up a possible clearing account in local currencies of the BRICS countries.1 This, in my view, will provide avenues for generating additional demand within the region while avoiding shocks from exchange rate volatility, especially for member countries like China with its large trade balances in US dollar.
The possibilities of settling payments in local currencies have already been tried by some of the BRICS nations on a limited scale by using bilateral swap deals among themselves. However, the limited scale and the absence of multilateral settlements across the region have often hampered their endeavours to protect themselves from currency market fluctuations. Most of the resultant problems are related to the dependence on the US dollar which is used in most international transactions.
The setting up of a possible clearing account among developing countries has been suggested before. The idea was initially mooted by Keynesat the end of World War II (Keynes 1980). Keynes offered the settlement of US credits by debits held by the United Kingdom (UK), the largest debtor at that time. However, this plan was not acceptable to the reluctant creditor. A similar suggestion has recently been made by Jan Kregel for setting up a global clearing-house or settlement system for trade and payments on current account, with credit generated by surpluses used to buy imports from the countries with debit balances (Kregel 2015).
Kregel draws attention to the possible benefits of the plan for developing countries which are facing problems in meeting deficits in their balance of payments. He says,
From the point of view of the current difficulties facing emerging market economies, the basic advantage of the clearing union schemes is that there is no need for an international reserve currency, no market exchange rates or exchange rate volatility, and no parity to be defended. Notional exchange rates can be adjusted to support development policy, and there is no need to restrict domestic activity to meet foreign claims. Indeed, there is no need for an international lender or bank, since debit balances can be managed within the clearing union.(Kregel 2015)
With BRICS coming up as a forum for articulating the voice of the emerging economies and, at a later stage, of the developing countries at large, a clearing account within the region may turn out to be workable. The scheme as proposed in this article follows what Keynes called the “banking principle,” defined as “…necessary equality between credits and debits, of assets and liabilities.” As Keynes pointed out, “… if no credits can be removed outside the banking system, but only transferred within it, the bank itself can never be in difficulties”(Keynes 1980).
The framework was based on the notion of a clearing union where “... credits were automatically provided to the debtor countries to spend” (Kregel 2015).
It may be mentioned here that bilateral clearing arrangements provided a way out for some European countries, including Germany, in the inter-war period to settle the external payments problems. In an earlier study, the author discusses the use of the “rupee payments arrangements” between India and the East European countries during the 1960s, which considerably facilitated transactions between the two by opening up new channels of trade and its settlement with additional investments (Sen 1964).
A clearing account system along similar lines, this time in local currencies of the BRICS nations, can be used for inter-country payments within the region. Each country within the group can settle her bilateral trade surpluses and deficits with the other four members without involving the use of non-BRICS currencies (like the US dollar, etc). For example, China’s exports to India will be paid for by the latter in rupees, and the renminbi (RMB) will be used by China to pay for imports from India. The net balances (in this case China’s trade surplus) will remain in rupees as a credit for China. Thus exports from any of these countries to another BRICS member will be paid for in the local currency of the importing country.
The net balances, comprising a pool of individual local currencies, will remain within the BRICS and be deposited with the NDB. The sum, a pool of individual currencies, can be utilised by the respective creditor nations to import from deficit countries, thus creating more trade within the region. Alternately, the sum can be lent out by the NDB to one or more of the five members, subject to the consent of all members and consistent with the norms specified in the original agreement of the NDB.
To avoid further problems, the prevailing cross exchange rates of currencies for individual countries can be used to settle the two-way transactions in local currencies—for instance, the deficit country paying back the surplus in the local currency of the latter. However, the volatility in exchange rates can be avoided by freezing the prevailing cross rates by having forward contracts. This will protect the intra-BRICS exchange rates from fluctuations in other currencies like the US dollar.
BRICS’ Bilateral Trade Balances
To provide a convincing picture of the hypothetical scenario as above, we constructed a matrix of the bilateral trade balances between the individual BRICS members by using the World Integrated Trade Solution (WITS) data for 2014. The individual bilateral balances and their aggregates are in US dollars, which, at prevailing rates of local currencies, will form the pool within the BRICS. The pool in local currencies can be used by creditor nations to purchase from other BRICS members. The transactions can be based on the prevailing cross exchange rates vis-à-vis the dollar, which, as mentioned, can be frozen by using forward rate contracts. While we expect that the new system of having a clearing account would generate additional demand for goods as well as investments within the BRICS, it will also restrain China, the major creditor nation within the region, from using her trade surpluses (within the BRICS) to invest in dollar denominated US Treasury bills.
The anomalies in bilateral trade data in Table 1,2 reported on a gross basis, indicate the need to qualify the above by looking at trade data on a value added basis at domestic sources. The problem can be detected in the discrepancy between the bilateral trade balances reported by the respective trade partners. The efforts made by the World Trade Organization (WTO) to draw attention to the issue in their “Made in the World” initiative offer some data that may help to narrow down such discrepancies (Maurer 2011). We are unable, at this stage of our research, to look beyond gross trade data despite their limitations.
The BRICS financial institutions, along with the clearing account proposed in this article, can herald a new financial architecture which has the potential to be beneficial not just for BRICS but for global financial system at large. Of these benefits, five important ones are outlined.
First, since those settlements will no longer rely on the dollar or other major currencies as unit of transactions, the exchange rate fluctuations across major currencies will not impact the cross rates between the individual BRICS currencies as long as these are kept frozen with forward contracts renewed over time.
Second, arrangements to use the bilateral trade surpluses within the BRICS by those with trade deficits would generate additional demand within the member nations by creating new channels for intra-BRICS trade. Hopefully, this will stimulate the real economy in terms of output and employment.
Third, the transfer of surpluses to meet deficits can even be treated as a loan, to be adjusted by other transactions of the NDB.
Fourth, trade surpluses earned by individual members (say China) will remain within the BRICS as investment and will not be used as assets in US dollar, avoiding sources of vulnerability.
Finally, BRICS may devise ways and means to channelise capital flows in a manner which strengthens its institutions and generates real demand, say with infrastructures via the newly formed AIIB, rather than be used in activities of a speculative nature.
1 I used an earlier version of this proposal in a discussion paper of the Research and Information System for Developing Countries which was presented at the BRICS Academic Forum held in October 2016 at Goa. See Sunanda Sen (2016).
2 Data collected by Zico Dasgupta for this table is gratefully acknowledged.
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