Brics Needs Private Sector To Achieve Its Financial Goals

There is a political desire born from economic realities to create new financial vehicles among the Brics nations. Defending against external inflationary shocks, high debt servicing costs, a shortage of foreign exchange reserves, and the unilateral application of sanctions are all major factors, although increasing inter-Brics trade and investment are other prominent motivations.

Collectively, these factors have led to calls for the creation of a Brics payment system and even the formation of a joint Brics unit of account and trade currency. While developing government-led cross-border payment infrastructure could prove useful, the global financial system is still predominantly intermediated by private sector banks and investors.

As such, the original Goldman Sachs conception of Brics as an investment opportunity could be the key to unlocking the bloc’s full financial potential. Private sector participation in the creation and marketing of Brics financial products would encourage greater inter-Brics capital flows, and this in turn could deepen economic integration between the member states and their partners. 

For example, in Russia, there has been a concerted effort to promote the use of the yuan in the domestic banking system. This has seen the creation of yuan denominated savings accounts for customers at commercial banks, an increase in the yuan as a share of Russia’s reserve holdings at the central bank, and Russian firms selling yuan denominated bonds to raise capital.

However, shortages of Chinese currency within Russia following the start of the War in Ukraine hindered these efforts and negatively impacted the exchange rate of the ruble. Although China refused to sanction its neighbour, Chinese businesses remained circumspect due to the risk of secondary sanctions and investors remained cautious about accumulating ruble denominated assets, whether cash, stocks, or bonds, to the same extent Russians sought out the yuan.

Reciprocal investment demand would have helped balance exchange rate fluctuations and made higher volumes of yuan available for the Russian market, illustrating how the network effect of a Brics financial eco-system still requires the banking sector and retail investors.   

Russian energy flows have subsequently been redirected to China, higher trade volumes have led to the accumulation of foreign exchange, and the yuan liquidity problem has been resolved. The ruble recovered most of its losses as yuan liquidity increased, and both nations have saved billions in reduced exchange rate fees via direct trade in local currencies.

This suggests that as inter-Brics trade and investment levels increase, external pressures could be effectively ameliorated. China, in particular, is well placed to withstand economic pressure due to its superior trade volumes and large domestic market. India has been more reluctant to openly challenge the dollar system. However, its reliance on Russian energy makes deeper co-operation with the BRICS towards alternative payment systems inevitable.

Governments and academic institutions in Brics countries are consequently making efforts to develop new financial vehicles in support of inter-Brics trade and investment. Nevertheless, the participation of the private sector remains central to the ultimate success of this process.

The recent weakening of the dollar could support this shift towards alternative trade currencies as the dollar loses its store of value status due to higher levels of inflation. Meanwhile tariffs and the ongoing disruption to Middle East energy exports could lead to lower trade volumes with the US as well as fewer petrodollars.   

Besides currency swops at the central bank level, the public sector’s ability to influence the structure of the global financial system remains relatively modest. As such, the most effective way for the Brics to increase trade and investment between its members is to increase capital exchanges within the private banking sector. This has already begun to occur with the alliance having demonstrated that inter-Brics investments can be profitable for investors. 

For the most part, Brics currencies have declined relative to the US dollar in recent decades and it has been ‘hard’ currencies such as gold that have benefitted whenever there had been a loss of confidence in the US financial system. This has benefitted Brics commodity exporters such as Brazil and South Africa, who run commodity trade surpluses, but has puts financial pressure on other Brics states, such as Egypt and India, while discouraging otherwise good investments.   

That said, the dollar has finally shown signs of weakness relative to some emerging market currencies, and a combination of higher inflation and persistent budget deficits could see the US currency come under sustained pressure especially if higher bond yields result in a market correction and the Federal Reserve decides to increase its balance sheet further.  

For Beijing, China’s desire to boost export revenues has disincentivized the internationalization of the yuan. But considering on-going tensions between Washington and Beijing, there are signs that China may no longer be interested in supporting a strong dollar. China remains a net seller of US Treasuries, and has recently been joined by the biggest holder, Japan, who has been left with few other options as it strives to defend a collapsing yen in a high oil price environment.   

Nevertheless, the goal for Brics must be to create an eco-system where national currencies reflect the relative strengths and needs of each nation rather than competing as alternatives to the dollar. A joint unit of account based on a basket of Brics currencies would be an attractive innovation due to the risk-reducing effects of diversification, although this diversification also occurs naturally once countries start conducting trade in multiple currencies. 

Meanwhile, Brics-based equity and bond markets often offer exceptional domestic currency returns undermined by foreign exchange dynamics. As such, the use of alternative currencies for inter-Brics trade could also encourage increased investment within the bloc as Brics better integrates private sector financial market participants.

Brics governments must continue to facilitate this development by persisting with efforts to promote alternatives to Western cross-border payment systems and by increasing the volume of central bank currency swops to facilitate trade in local currencies. This will strengthen the currencies of Brics nations, increasing real returns for foreign investors interested in the high growth rates, bond yields, and revenue generating capacity of Brics markets. 

Academics at Brics country universities could support these efforts through the creation of a hypothetical Brics currency in order to measure its performance over time. Various weightings which include gold and other commodities can also be tested along with formulas which adjust the share of the underlying currencies on the basis of trade flows.

The respective stability and nation specific utility of each hypothetical currency formation can then be measured to help inform decision making with respect to the creation of an actual unit of account and eventual medium of exchange. Sharing the results of these studies in the media would normalise the idea of a Brics currency further. This interaction between academia and the media is especially important considering the role confidence plays in valuing fiat money.

That said, the most likely solution will simply be to integrate various BRICS central bank digital currencies into a unified and decentralized digital payment system which will have the benefit of faster transaction times without the usual foreign exchange costs. This is the direction of travel and existing pilot programs are likely to be expanded in the coming years.    

Efforts to de-dollarize the global financial system are already proving attractive to many nations and a weakening dollar has already made Brics investment more attractive to foreign investors. Nevertheless, despite recent improvements, renewed efforts must be made to better integrate the private sector into this on-going process.