Will We See a Common Currency for the BRICS States?
6 September 2023
BRICS: economic clout and ambition
"BRICS" is an acronym made up of five predominant “emerging economies”: Brazil, Russia, India, China and South Africa, which combined generate about one-third of global GDP. The grouping was formally established in 2010 and has five headquarters in Shanghai, Pretoria, New Delhi, Moscow and Brasilia. The five countries established joint diplomatic meetings in 2009, and the countries participating in the alliance hold annual summits to coordinate their strategies. It has been decided to expand the alliance to include six more countries, others may follow.
The question of a monetary alternative is often justified by the fact that contemporary global trade is difficult to manage payment flows without using the US$ in the process.
Europeans have witnessed the process of introducing a common currency, with other countries joining over time, for almost a quarter of a century, and the euro has generally been economically beneficial. Behind the BRICS countries' plan for the creation of a common currency, however, are different intentions, and the comparison with the euro is therefore not suitable. Nonetheless, the question arises under which conditions the BRICS states’ plan could lead to a similar success.
While this topic does have a political dimension, the interest here is only on the functional side of the issue.
No currency without a single Central Bank
The most important prerequisite for a functioning currency is a strong and self-reliant Central Bank. This institution is empowered to use the nation’s or group of nations’ monetary resources and steering instruments in the interest of the currency area.
Central Banks are entities that have learned and continue to learn under the influence of crises to keep financial systems functional and stable.
Today, such institutions typically operate according to their own policies and are largely independent of political government. Central Bank areas of activity are all related and partially overlap, but may be subdivided as follows to maintain perspective:
The chart is a simplified representation. However, it should give an approximate idea of the complexity of the tasks involved.
A Central Bank for the BRICS states
Every currency area has regions that are economically stronger or weaker, that are expanding or contracting. However, this area must be coherent so that the economic policy of the government institutions and the financial policy of the Central Bank can implement measures aimed at balancing.
But how can a Central Bank steer and stabilise when developments in a currency area depend on divergent economic processes, which are steered by mutually independent governments all over the globe using different instruments? Can a Central Bank set different impulses in a politically non-unified currency area, e.g. impose different interest rates? What would happen if it did?
In addition, aren't serious conflicts to be expected if strategic decisions of a supranational Central Bank are incompatible with the policies of a member state? Or would such a Central Bank not even be capable of making decisions owing to the representatives of participating nation states in the bodies of the institution vetoing or blocking each other?
The likelihood of such disruptions is not small when the lines of development and the challenges of included national economies do not correlate with each other and can even be have opposite goals. A single currency replacing national currencies is not a realistic prospect if the integrated economies are not coherent and the government systems are not obliged to exercise coordinated control. Figuratively speaking, the driver of a car cannot turn left and right at the same time if different passengers have different destinations.
A less far-reaching model
The introduction of a common currency would be easier if the scope of the monetary union were limited.
For example, a potential BRICS common currency does not need to be universal, i.e. it should not replace the national currencies of the member states. Rather, its use could be reserved for international payment transactions outside the sphere of influence of the US$ area. In this case, a Central Bank would also be necessary. However, this institution would not bear the burden of responsibility for five or more national economies. Instead, its focus would be on ensuring international financial transactions.
With their New Development Bank based in Shanghai, the BRICS countries have already created a nucleus from which a Central Bank and a global payment system – a SWIFT alternative - could be developed. Most likely the technical capability for this already exists.
A comprehensive system would have to be established whereby the conversion rates into national currencies for which there is not a consistent international exchange rate would need to be fixed continuously. Such a task would not be trivial, because measuring the exchange rate of the common currency requires an external benchmark. In the case of the European Currency Unit (ECU) created in 1979, this was the US$. The value of the African Financial Community franc, created in 1994 for international trade between member states of the West African Economic and Monetary Union (WAEMU), is pegged to the euro.
The determination of fair foreign exchange rates is difficult if one or more of the included currencies is not internationally tradable or is only internationally tradable to a limited extent. Tensions may arise between participating states if participants with freely traded currencies feel disadvantaged.
Furthermore it would be necessary to regulate who has access to the system and under what conditions. These can be legal entities or citizens of only of the BRICS member states or nations of which the BRICS system has approved. The exclusion of countries from which the BRICS region seeks distance will be challenging in the details.
An asset backed currency?
Another option may be an asset backed currency in which the benchmark of value is a precious metal rather than a national currency. Many Central Banks, and especially those of the BRICS countries, have made considerable gold purchases this year. From these holdings, the BRICS Central Bank could secure the full or partial backing of the new BRICS currency. This approach to bolstering the new currency is championed by one BRICS member state in particular.
The gold holdings necessary to fully or partially cover the BRICS currency would need to be transferred to the BRICS Central Bank. To a large extent, the Central Bank’s ability to secure user confidence and manage the money supply would depend on its control over these holdings. The quotas for property transfers would be subject to a distribution formula agreed between the member states.
However, the debate on the pros and cons of a gold-backed currency is far from over. A key aspect of any planning process for a gold-backed currency will be clarifying how the exchange value of a gold ounce is determined. BRICS countries would likely prefer to avoid the US$-based London Bullion Market Association procedure. However, simply establishing a different procedure for valuing the BRICS Central Bank's gold holdings is not so easy as any discrepancy between the pricing according to the a new procedure and those from the LBMA will become targets of professional arbitrageurs. The use of the currency for speculative purposes could affect the stability of the BRICS currency.
From a historical perspective, it should be noted that the pegging of value to gold, while providing warm feelings at times, did little for economic stability. In older times, rulers exploited such systems by obtaining capital through secretly changing the alloys of precious metal coins. The pegging of the money supply to be created by central banks would also lead to contractions in commercial bank lending capacity when there was not enough gold available to back it up. Furthermore, in times of collective distress, central banks sold gold, triggering turmoil in their areas of responsibility. Is it really advisable to reopen a laboratory where there have been many failures and explosions in the past?
The repeatedly asked question of whether it is possible to narrow the scope of the US$ as the current reserve currency for international capital movements among the BRICS countries may attract attention. In fact, however, there are a number of tough conceptual nuts to crack before such an undertaking will be a justifiable proposition.