The Beijing Count
What needs to be done to increase investment and trade within the BRICS nations? One solution is to expand the use of national currencies in mutual settlements. Every BRICS member would benefit from such an arrangement.
This spring, I heard a joke in China at the Boao Forum for Asia (BFA). When asked whether BFA might be able to launch a common currency in the foreseeable future, the answer was, Yes, of course – the yuan.
As the saying goes, there’s a grain of truth in every joke. It’s no secret that foreign trade transactions in renminbi today are many times greater than those in other BRICS currencies. Moreover, China’s currency became one of the top-five most used currencies in the world last December. According to SWIFT, nearly 2.2% of international financial transactions were denominated in yuan that month. The only currencies that saw more transactions were the Japanese yen (2.7%), the British pound sterling (7.9%), the euro (28.3%), and the US dollar (44.6%). For comparison, the Russian ruble was in 19th place on that list. It accounted for 0.4% of global payments.
China’s success – all the more impressive given that the local currency is still not freely convertible – was certainly no accident, quite the contrary. It was the result of continuous work aimed at internationalizing the yuan. China launched its pilot project of foreign trade settlement in national currencies in only 2009. In the short time since, Beijing has agreed on the use of the yuan in trade with more than 170 countries. Another 33 countries have signed agreements on currency swaps for a total amount of more than 3 trillion yuan. This includes some of the BRICS countries: in 2012, 190 billion yuan with Brazil; in the fall of 2014, 150 billion yuan with Russia; and in April of 2015, 30 billion yuan with South Africa. According to some reports, another 40 countries use the yuan as part of their official foreign exchange reserves. The aggregate amount of such reserves is $100 billion (the IMF estimates).
At the same time, Chinese authorities have begun to liberalize the financial system by simplifying the access of foreign issuers to the debt markets of mainland China. This July, it was announced that local regulators proposed allowing a number of foreign financial institutions to place bonds in yuan. Access to the local inter-bank bond market for foreign central banks, sovereign wealth funds, and international financial institutions may be simplified too. All these steps, among other things, will stimulate demand for the yuan and encourage its addition to the IMF’s basket of currencies – the SDR (special drawing rights for IMF member countries), which would automatically make it a world reserve currency. This decision, long awaited by Beijing, may be made as early as November 2015 at the next IMF meeting. Even if it happens just next year, the trend is clearly set up. As a result, according to experts’ calculations, central bank reserves denominated in Chinese yuan will increase by $100 billion, although a more moderate reaction is also possible.
Other BRICS countries cannot yet boast similar successes. Today, the share of national currencies in bilateral trade among the BRICS members does not exceed 10%, and almost all these settlements are serviced in yuan, while the remaining 90% are carried out in dollars and euros. For example, last year the share of the ruble and the yuan in trade between China and Russia amounted to about 7%.
A likely addition of yuan to the IMF’s basket of currencies will automatically make it a world reserve currency. This decision, long awaited by Beijing, may be made as early as November 2015 at the next IMF meeting. As a result, central bank reserves denominated in Chinese yuan may increase by $100 billion
This situation is not ideal for any of the countries. Ultimately, it translates to additional transaction costs: the seller usually relies on financing in the currency of the contract, and the buyer, on the use of this currency as the currency of investment. In other words, the use of the dollar and the euro in transactions automatically makes the BRICS countries dependent on the ‘opinion’ of a third party – the US or Europe. And there is no guarantee that this opinion will not change.
The transition to national currencies in mutual account settlements is an important part of a comprehensive solution to this problem. The trade turnover between Russia and China has grown 5.7 times over the past five years, to about $95 billion in 2014. At the same time, the leaders of both countries have set a goal to bring trade turnover to $200 billion by 2020. Both countries are interested in expanding mutual investments and are discussing a number of large joint investment projects, both in Russia and in China, in the areas of energy, infrastructure, and industrial production.
Among other things, this involves offering partners greater access to national capital markets and creating the necessary financial instruments. For example, fluctuations in the balance of trade between the two countries can be smoothed through the use of money market instruments and loans in both currencies. The opening, at the end of last year, of an intergovernmental swap line between China and Russia was the first step towards the creation of suitable modern infrastructure markets of such instruments.
Short-term financial instruments will form the basis for issuing long-term debt instruments in rubles and yuan in order to finance joint projects. Reference points for such loans can be provided by high-quality issuers from the two countries. We are talking about the need for the issuing of mutual bonds by sovereign and quasi-sovereign borrowers in Russia and China in yuan and rubles, respectively.
One nice ‘side effect’ will be the development of a national institutional investor industry, which will have the opportunity to invest in long-term financial instruments in rubles and yuan. To a certain extent, the creation of such a system is a matter of the intellectual challenge that is facing regulators, policy makers, and economic entities in both countries. But there are no insurmountable obstacles here – it is simply important to ensure the right conditions. Among them is mutual access to national markets for issuers and investors, free movement of capital between the two countries for all financial transactions, and synchronization of financial infrastructure with the support of regulators from both countries.
Such an arrangement is universal, and with certain innovations can be applied to building bilateral relations among all the BRICS countries. At the same time, the perceived dominance of the yuan is not a threat but an objective reflection of the current proportion of China in mutual trade, which can then be smoothed with the development of appropriate financial instruments and infrastructure. The future benefits outweigh the possible present-day costs. It’s time to take the necessary actions. If we do not do it ourselves, it will be done for us.