The BRICS are trying hard to show muscle and relevance in the world. On the agenda for a summit meeting in August will be an enlarged membership, and the creation of some form of new currency to compete against the US dollar. The larger aim is to help provide an alternative geopolitical pole to that of the west.
It might well turn out to be a case of overreach.
BRICS brings together a diverse set of countries, Brazil, Russia, India, China, and South Africa. They don’t have sufficiently shared interests to form an actual alliance. In fact they have more important competing interests that divide them. While Russia and China share an enemy in the US and the West, they are deeply suspicious of each other’s intentions. India has a border dispute with China and is wary of Beijing’s growing assertiveness. South Africa shares interests with Brazil in the South Atlantic and India in the Indian Ocean.
Most BRICS countries will be very wary of the entire project being driven by the big man, China. All of that is insufficient to form a close alliance worthy of a substantial investment.
This does not exclude an interest in stimulating trade and investment, but a shared currency and formal alliances are steps too far.
Currently the grouping calls itself “a mechanism” for leading emerging market countries to promote peace, security, development, and cooperation. That all sounds like good stuff, but how far can it really go, given the deep differences in its membership, and the possibility that it might take on about 20 countries who have shown an interest in joining. The more countries, the more unwieldy it could become.
The very BRIC idea, without South Africa, came from a paper written in 2001 by Jim O’Neill, a Goldman Sachs economist, who pointed out that these would be the world’s fastest growing countries and would dominate the world economy by 2050. Seized by the idea, the BRIC leaders met in 2009, and a year later South Africa was admitted as a member, not due to its economic clout, but largely due to the Mandela legacy.
There was never any suggestion from O’Neill that these countries shared fundamental interests.
A decision to even start the process of launching a form of still undefined reserve currency will be a big test of whether some of the BRICS’ big ambitions are realistic. The most practical initiative so far has been the launch of the BRICS bank, the New Development Bank, to finance projects.
What might curb the ambitions for the currency project is that it is overwhelmingly politically driven to make a jab at the US. South Africa’s minister of international relations, Naledi Pandor, has said a reason the BRICS are looking at alternatives to the US dollar is to, “ensure that we do not become victims of sanctions that have secondary effects on countries that have no involvement in issues that have led to these unilateral sanctions.”
The immediate aim then would be to sidestep western sanctions on Russia by setting up an alternative international payment mechanism. But this might not solve the problem of by-passing sanctions. Banks in most BRICS countries might be reluctant to use a new payment mechanism that replaced the widely used SWIFT system, as it would threaten relations with western banks.
An option to start off with would be to launch a type of unit of account based on a weighting of each of the BRICS in global trade. This would be similar to the International Monetary Fund’s Special Drawing Rights. Trade between members could then be made in this unit of account. But oil and most internationally traded goods are priced in US dollars. The value of the unit of account would largely be a reflection of the exchange rate of the Chinese yuan. That means an additional exchange rate risk, as most trade is dollar based.
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A new currency would be a far more ambitious project and require the setting up of a central bank. The central bank would require reserves to back the new currency. At this point the national central bankers might tell their political masters that they would prefer to hold foreign reserves in the US and Europe, rather than backing an experiment.
Establishing an alternative reserve currency is not an overnight project.
There have been few reserve currencies in history. Gold and the gold standard are the oldest. Sterling was accepted throughout the British Empire, but in the post-war world it is the US dollar that has assumed this role. The US dollar is the main currency for international trade. Commodity prices are quoted in dollars, and states largely hold theír foreign exchange reserves in dollars.
There has long been talk about how the US dollar will be replaced as a reserve currency. In the late 1980s there was speculation that the Japanese yen would diminish the role of the US dollar, due to the scale of US debt and the rising US trade deficit with Japan. It never happened. According to the IMF, at latest count, at the end of the first quarter of this year, the US dollar accounted for more than 60 percent of foreign exchange reserves held by central banks or monetary authorities. The euro amounted to slightly more than 20 percent, and the yen, the British pound, and the Swiss franc together amounted to about 10 percent. Holdings of the Chinese yuan are slightly below three percent, but rising.
Back in the early 1990s, the US dollar accounted for about 70 percent of foreign exchange reserves, but the rise of the euro, and worries about dollar volatility have encouraged central banks to diversify their portfolios of currency holdings.
A reserve currency project might be a more credible exercise if the BRICS were each other’s major trading partners and were already part of a free trade arrangement, and if it was already in domestic use. The Euro was only launched after the European Union had been a free trade area for many years and there had been a degree of coordination on economic policy.
There are benefits to a country from dominant reserve currency status, as large trade deficits can be run to the extent that confidence is maintained. But there are also costs, including maintaining minimal foreign exchange regulations and being open to investment.
It is not clear that China has ambitions to see its currency perform this reserve role. China restricts the convertibility of the yuan into foreign currencies and its international use. Growing tensions with the US mean it is keen to prevent capital outflows and wants to maintain its sizeable balance of payments surplus. That alone would restrict the BRICS currency performing a reserve role.
The BRICS certainly has a role in voicing the concerns of emerging markets. But taking on a larger political role and issuing a currency are likely to be increasingly difficult steps, particularly as the group takes on new members.
Jonathan Katzenellenbogen is a Johannesburg-based freelance financial journalist. His articles have appeared on DefenceWeb, Politicsweb, as well as in a number of overseas publications. Jonathan has also worked on Business Day and as a TV and radio reporter and newsreader.
