Recent efforts by China and the BRICS to reform the global financial system could lead Western financial institutions, such as the IMF, to show more leniency towards their debtors. Just weeks after Beijing announced a substantial $550 billion in local currency swops, the IMF responded by announcing a review of its contentious surcharge policy, which applies additional charges to struggling borrowers.  

This is a significant development. If the IMF were to abandon surcharges, this would be a huge relief for many of the world’s most indebted nations. This willingness to adjust long-established policies suggests that the growing competition for influence in global finance between the BRICS and Western banking institutions could help reduce the cost of development capital.     

Chinese Currency Swops

In March, China unveiled plans for a massive currency swap initiative with developing nations designed to facilitate increased trade in local currencies. Through this mechanism, the central banks in participating emerging markets can exchange their local currencies for transactions with China. This could help these states save billions in foreign exchange costs. Moreover, this move increases the utilization of the yuan, bolstering its status as a global reserve currency.

Given that the bulk of global trade still revolves around the US dollar, the recent announcement signals China's proactive stance in advancing the yuan's prominence in international trade. This strategic move also dovetails with the broader objectives of the BRICS who advocate for the use of local currencies in trade transactions, as opposed to remaining overly reliant on the dollar.

The People’s Bank of China’s recent proposal includes currency swap agreements with 29 developing nations, including fellow BRICS members, with a total value exceeding $550 billion. While a portion of these funds could be retained by central banks as foreign reserves or be allocated to debt repayments (which we have already seen with Argentina), Beijing’s primary objective is to increase local currency trade and protect Chinese exports from US sanctions.

Despite the modest scale of this initial $550 billion in currency swops compared to the vast volume of global trade currently denominated in US dollars (estimated at over $15 trillion per annum), the implications could be far-reaching over time, and China has clearly ramped up its ambitions with respect to internationalising its currency.  

As other emerging markets initiate similar currency swap agreements of their own, a substantial portion of global demand for US dollars in trade settlements could eventually be supplanted by the yuan and other emerging market currencies. This could help reduce downward pressure on the currencies of developing countries and lead to reduced inflation and interest rates, making investing in these high-growth markets more attractive as foreign exchange risks decline.

The IMF Responds

The IMF traditionally levies surcharges on nations that exceed their allocated borrowing limits or delay repayment. This policy has seen borrowing costs on some of its outstanding loans rise to as much as 8%, further burdening struggling nations like Argentina, Egypt, and Ukraine, whose collective IMF debts amount to approximately $70 billion.

In the past, the IMF defended the surcharges as essential to its financial framework, aiming to deter excessive borrowing or prolonged repayment periods. However, borrowers argue that the charges deplete the resources needed for food and healthcare and make repayment even less likely. This policy has proven especially contentious in light of high inflation and interest rates following excessive fiscal and momentary policy stimulus by the US, the IMF’s largest creditor.

After China's currency swap declaration, the IMF issued a statement that a number of its board members were open to reassessing these surcharge policies and that the fund is conducting an internal review of the policy. Nevertheless, overall support among board members for reducing the fees remains uncertain, and a 70% vote in favour of the change is required for the change to be affected.  

Chinese loan conditions are rarely disclosed to the public, which makes comparisons difficult. However, an 8% repayment fee for the IMF’s most indebted borrowers is more than double pre-pandemic levels. Such punitive charges could ultimately make Chinese loans more appealing, undermining the US-controlled IMF’s political leverage and global reputation.

The number of countries subject to IMF loan surcharges has increased to 22 nations, up from eight states in 2019. These nations are set to pay as much as $10 billion in surcharges over the next five years leading to fears in the West that countries facing debt distress could be inclined to switch allegiance from Washington to Beijing.       

BRICS countries like Brazil and India have been outspoken critics of the high cost of development finance and both nations raised the issue at the most recent meeting of the G20. Their concerns were addressed with platitudes by the US Treasury Under Secretary for International Affairs, Jay Shambaugh, who claimed the Biden administration was “open to new approaches”. But it was only six months later, after China’s currency swops were announcement, that the IMF reacted.

Ukraine being on the hook for some $3 billion in additional charges is another significant factor. The US has poured considerable resources into Ukraine, so applying surcharges could be seen as giving with one hand and taking with the other. Ukraine’s inability to repay its debts remains an ongoing issue, with Congressional Democrats introducing the Stop Onerous Surcharges Act in the hope that the Treasury Department could pressure the IMF to discontinue the practice.

Efforts by the BRICS states to reform and develop alternatives to the global financial system may finally be bearing fruit. In addition to calls for trade in local currencies and the creation of a joint BRICS unit of account, a struggling Ukraine and higher global interest rates have put pressure on the US to implement reforms. That said, considering the timing of the China’s currency swops and the IMF’s policy review announcement, it could be the growing rivalry between the US and China that ends up having the biggest impact on the future of global finance.