The proposal for a unified reserve currency backed by the BRICS nations – Brazil, Russia, India, China and South Africa – has generated much discussion about its potential impact on the global financial system and the US economy. As rising economic powers, the steps taken by BRICS central banks to shift away from an overly dollarized monetary system deserve close attention from investors and policymakers worldwide.
Understanding the Impetus Behind the BRICS Currency
First proposed during the 2012 New Delhi BRICS summit, the idea for a joint cross-border payment system and currency reserve pool aims to facilitate greater trade and financial integration between BRICS economies. Providing an alternative to mediating payments through dollars was an important motivation behind this proposal.
This initiative aligns with BRICS‘ broader focus on cooperating on monetary and financial matters – as outlined again during the bloc‘s 2013 Durban summit.
Reflecting on the goals, Russia‘s former finance minister Anton Siluanov commented:
"Russia shares the BRICS countries’ concerns over excessive dependence on limited reserve currencies. We are pleased to see the BRICS Trade and Development Bank initiative acquire distinct shape along with the large-scale financing of joint projects using domestic currencies."
This desire to circumvent the prevailing dollar-centric financial system also led to the creation of institutions like the New Development Bank (NDB) based in Shanghai. The NDB provides financing for infrastructure and development projects within BRICS and other emerging economies.
The creation of the China-led Asian Infrastructure Investment Bank also reflects similar priorities. These new institutional setups bypass established Western-dominated entities like the IMF and World Bank.
The Economic Significance of BRICS
Often represented by the ‘B‘ and ‘I‘ of Brazil and India, the BRICS grouping consists of major emerging markets on four continents:
Brazil – Latin America‘s largest economy, with a GDP of $1.6 trillion in 2022 that has doubled since 2000. Abundant natural resources and a large services sector amid social inequality.
Russia – Energy exports underpin this $1.7 trillion economy which has rebounded in recent years thanks to rising oil prices. Impacts from Western sanctions in response to the Ukraine invasion have been limited.
India – With a soaring population of 1.4 billion and 2022 GDP exceeding $3 trillion, India is projected to become the world‘s 3rd largest economy by 2030. Booming services and manufacturing sectors.
China – The manufacturing workshop of the world continues to deliver over 6% GDP growth, with output reaching $18 trillion in 2022. The world‘s largest economy in PPP terms and leading trading nation.
South Africa – An economic giant in the African continent, though current challenges like power shortages have constrained growth. Resources, tourism, and financial services drive its $430 billion economy.
Collectively, BRICS accounts for over 40% of the global population and 25% of world GDP (by exchange rates). In PPP terms, this share exceeds 35%. By 2025, BRICS combined GDP could reach $40 trillion.
BRICS also boasts young demographics, rising consumer classes, complementary trading structures, and accelerating digital connectivity – underpinning its future expansion.
Benefits the US Derives as the Dollar Hegemon
By serving as the primary global reserve and transaction currency, the US dollar confers unique advantages to American economic interests:
Seigniorage revenue windfall – As other nations demand dollars to hold as reserves and facilitate trade, they effectively provide an interest-free loan to the US. Estimates suggest the US earns $90-140 billion annually in seigniorage gains.
Lower borrowing costs – Higher demand for dollar assets like Treasuries allows the US government to fund budget deficits more cheaply – by 100 basis points according to some studies. US corporations also gain cheaper financing.
Ample deficit financing – Persistent current account and fiscal deficits have been easily financed given external demand for dollars and dollar-denominated assets.
Convenient international transactions – Americans pay minimal currency conversion and hedging costs when trading globally compared to firms in other countries.
Geopolitical leverage – Dollar dominance empowers the US to impose biting secondary sanctions and export controls over vast areas of global trade and finance.
But these unique privileges depend on the rest of the world using the dollar for reserves and trade. Any decline in external dollar demand would erode the exorbitant advantages.
Mechanics of How Central Banks Could Diversify Away from Dollars
Should major central banks opt to diversify away from dollars, how might this occur mechanically?
Some potential strategies include:
Refrain from further accumulation of dollar reserves during trade surpluses
Allow existing dollar reserves to gradually decline as a share of the total as other currencies are added
Actively sell dollars to buy reserves in other currencies like the euro, yen, or yuan
Switch the currency composition of sovereign wealth funds towards non-dollar assets
Covert dollar reserves into physical gold held domestically
Even marginal shifts by large players could significantly impact flows. For example, China halting new net purchases of US Treasuries in 2022 contributed to higher US yields.
Historically, major dollar share declines have been driven by events like the collapse of Bretton Woods and the birth of the euro. A deliberate move away from the dollar by central banks would be unprecedented.
Modeling the Impact Across Various Scenarios
Considering the profound implications, how might the BRICS currency realistically play out? We assess several scenarios:
Limited Adoption Scenario
Technical and political obstacles prevent full launch of BRICS currency
Utilized only for bilateral settlements between BRICS countries
No material shift in central bank reserve composition
Implications: Minimal impact on dollar dominance
Moderate Adoption Scenario
BRICS currency used for regional trade, but not as global reserve asset
BRICS central banks allocate 5-10% of forex reserves to new currency
Emerging markets start using for some trade transactions
Implications: Dollar remains primary reserve currency, but faces more competition
Significant Adoption Scenario
BRICS currency becomes a major global reserve asset
BRICS allocate 25%+ reserves to their currency, reducing dollar share to 50%
More countries start pricing oil/commodities in BRICS currency
Implications: Material deterioration in dollar‘s standing as primary reserve currency
Universal Adoption Scenario
BRICS currency universally adopted for trade and reserves globally
Dollar displaced as dominant international currency after 70+ years
Implications: Potent threat to US financial power and post-WW2 economic order
Of course, reality may end up between these stylized cases, but evaluating the bookends is insightful. Even moderate shifts could Signals from policymakers and investor preferences for reserve assets will be crucial to watch.
Evolving Attitudes Towards Holdings of Debt and Reserves
Market-based indicators can reveal how sentiment towards holding assets denominated in different currencies is evolving over time.
Yield curves provide one barometer. For instance, the yields offered on Chinese government debt relative to equivalent US Treasuries across various maturities reflect expected currency and default risks.
These cross-currency yield spreads have declined in recent years, suggesting growing comfort with holding Chinese bonds. A similar phenomenon may emerge with a BRICS currency.
Surveys of reserve managers worldwide also show a growing willingness to allocate a larger portion of reserves to yuan assets, at the expense of dollars. Similar surveys after the advent of a BRICS currency could provide valuable data on its acceptability as a reserve asset.
Expert Perspectives on Shifts in Major Currencies
What do academics and practitioners with expertise in international economics and central banking feel about the prospects for disruptive transitions in reserve currency status?
Pessimistic voices:
"Transitions between dominant international currencies are rare historical events that hinge on major technological, geopolitical and institutional transformations – a BRICS currency unlikely to drive a wholesale shift away from the entrenched dollar standard in the medium term" – Maurice Obstfeld, Berkeley Professor & ex-IMF chief economist
"Sizeable inertia effects, uncertainties about relative stability, liquidity and returns, as well as incumbency advantages suggest the USD will retain supremacy for the foreseeable future" – Linda Goldberg, New York Fed
Optimistic voices:
"A multipolar currency order is inevitable as economic activity disperses globally, and the BRICS bloc has the scale to accelerate this transition" – Arvind Subramanian, ex-Chief Economic Adviser to the Government of India
"Growing concerns about imposition of secondary sanctions and trade restrictions could motivate many nations to diversify reserves away from the dollar if viable alternatives emerge" – Paola Subacchi, University of London
Pragmatic voices:
- "Alongside the USD, a tripolar system with one currency from Europe and Asia gaining prominence is imaginable over the next two decades – a grouping like BRICS is as plausible a candidate as any" – Adam Posen, President of the Peterson Institute
A multipolar currency landscape appears likely, but full displacement of the dollar remains improbable in the short-run without major financial market upheavals.
Trade Architecture Can Enable Currency Acceptance
The progress in establishing institutions like the BRICS New Development Bank and integration initiatives around inter-BRICS payments and bond markets will shape adoption.
NDB‘s extending financing denominated in local BRICS currencies rather than dollars for investments is one approach. The NDB issued bonds denominated in yuan and rupee in 2016. Enabling cross-border project financing without needing dollar intermediation can boost use of the BRICS currency.
Similarly, creation of clearing and settlement mechanisms through associations like the China International Payments System reduces reliance on legacy networks like SWIFT that principally facilitate dollar flows.
This "plumbing" is essential to any currency attaining broad internationalization. Seamless usage for trade and asset transactions allows network effects and critical mass for a currency to develop.
Corporate and Investor Response Within BRICS Economies
The advent of the BRICS currency would have noteworthy impacts within those economies:
Exporters may gradually shift invoicing and settlement into the BRICS currency to lower exchange rate exposure, especially for intra-BRICS trade.
Multinational companies and large conglomerates may issue bonds and raise capital denominated in the BRICS currency to diversify funding sources.
Portfolio investors and asset managers may increase allocation to BRICS currency securities to hedge risks from dollar strength.
Declining dollar dependence may also accelerate development of local currency corporate bond markets as issuance in non-dollar currencies rises.
But concerns about liquidity, market depth and capital controls may temper initial corporate uptake. Full acceptance may take decades.
Households may also use the BRICS currency for transactions, remittances, and savings to protect against depreciation of their domestic currencies relative to the dollar.
Cascading Impacts on Indebted Emerging Economies
Aside from BRICS members themselves, a weaker dollar could impact emerging markets loaded with USD-denominated debt.
Countries like Turkey, South Africa, Indonesia, and Chile rely heavily on external dollar borrowing with high gross external financing needs. A stronger BRICS currency could exacerbate their repayment challenges on dollar liabilities, but also create opportunities to refinance some debts.
More broadly, reduced global demand for dollars would diminish the tendency for the US Fed‘s policies to influence capital flows, interest rates and financial conditions in emerging markets. These economies could gain some insulation and policy autonomy.
Data Snapshots on Trade and Reserves
The following tables help quantify China and BRICS‘ expanding footprint in the global economy:
Share of Global Trade
| Country | Export Share | Import Share | Total Trade Share |
|---|---|---|---|
| United States | 8.5% | 13.4% | 11.5% |
| China | 14.7% | 12.8% | 13.7% |
| BRICS | 21% | 22.1% | 21.5% |
Source: World Trade Organization, 2021 data
Foreign Exchange Reserves
| Country | Reserves (USD billions) | Global Share |
|---|---|---|
| United States | 243 | 5.2% |
| Euro Area | 933 | 20% |
| China | 3,160 | 67.3% |
| India | 561 | 11.9% |
| Russia | 296 | 6.3% |
| BRICS Total | 4,460 | 95% |
Source: IMF database, Q4 2022
This underscores both the rising proportion of world trade accounted for by BRICS economies, as well as the sizable dollar reserves at their disposal that could be diversified.
Concluding Thoughts
The launch of a BRICS currency could accelerate an ongoing shift towards a more multipolar global economy. It would enhance monetary sovereignty for its members. The dollar‘s position as the dominant reserve asset gives the US immense economic clout that isn‘t relished by many emerging economies.
While unlikely to immediately upend the dollar system, the advent of a serious alternative could gradually erode the greenback‘s privileged perch as international monetary premia. This could constrain US funding flexibility and impair foreign policy leverage.
However, it might also usher closer trade and financial ties between Western economies and emerging markets. The world has muddled through previous reserve currency evolutions. As long as the transition is orderly, a more balanced international monetary equilibrium could ultimately prove beneficial. But the road there is bound to have bouts of turbulence.
