In recent years, shortages and insecurities have increasingly plagued the global economy as it grapples with issues such as supply disruptions, energy shortages and food security concerns. In the realm of international finance, the world’s central banks had their fair share of risk, with one of the main shortages being the severe shortage of reserve currencies coupled with few options for diversification in the allocation of foreign exchange reserves. . These concerns were amplified in 2022 after geopolitical risks escalated and sanctions were imposed on Russia’s reserve assets worth hundreds of billions of dollars.
Such developments call into question the security of the dollar-centric international monetary system, reigniting discussions about the prospects for new reserve currencies such as the BRICS reserve currency. New entrants to the international reserve currency space that are likely to emerge may include not only national reserve currencies, but also baskets of currencies. If successful, these new entrants can transform the global monetary system towards greater optionality and less exposure to geopolitical risks.
Among the new entrants into the reserve currency space is the Chinese yuan, a national reserve currency that has slowly but surely taken a larger share of foreign exchange reserves and transactions in the global economy. However, just like the dollar and any other national currency, the yuan can be susceptible to country-specific geopolitical risk vulnerabilities, sanctions, and fluctuations.
So far, the expansion of the pool of reserve currencies composed of national currencies has progressed very slowly, which raises the question of whether a significant change in the monetary system is possible, given the sole focus on the currencies of national reserves. Hence the discussions around a BRICS reserve currency as a basket of currencies comprising the currencies of India, Russia, Brazil, China and South Africa.
The proposal to create a new reserve currency based on a basket of BRICS currencies was first formulated by the Valdai Club in 2018. The idea was to create a SDR-like basket of currencies made up of the five national currencies of the BRICS, potentially involving some of the other currencies of the economies of the BRICS+ circle. The choice of the composition of the BRICS currency basket was linked to the fact that they were among the most liquid currencies in emerging markets. The name of the new reserve currency – R5 or R5+ – comes from the first letters of the BRICS currencies, which all start with an R (the real, the ruble, the rupee, the renminbi and the rand).
The new basket of BRICS reserve currencies could act in concert with the greater role played by the national currencies of the BRICS to assume a larger share of the total currency transaction pie in the global economy.
There are a number of benefits of currency baskets as the proposed BRICS reserve currency. First, there is the reduction of the dependence/exposure to a single country risk, with cross-regional currency baskets reducing exposure to single-region risks. Second, there is the reduction of risks related to high volatility of a single Global South currency, as the platform that brings together currencies from economies with divergent trading profiles and varying exposure to shocks will result in lower volatility of the currency basket as such. For the countries of the South, a basket mechanism for the new reserve currency could serve as a incubator of new national reserve currencies. In the case of the BRICS reserve currency, the advanced status of the Chinese yuan could be used to support the status and potential reserve role of the currencies of other BRICS (or BRICS+) nations.
The emergence of new currencies as well as greater use of more national currencies or baskets of national currencies could also reduce the costs resulting from excessive dollarization of the global economy. Existing research points to significant costs borne by countries with relatively high levels of dollarization, with one such study noting that “the presence in residents’ portfolios of foreign currency assets and liabilities (or ‘financial dollarization’) has been presumed to influence monetary policy. policies in developing economies and, above all, to cause debtor insolvency as a result of exchange rate depreciations (the “balance sheet effect”)… [Furthermore,] financially dollarized economies exhibit more unstable money demand, a greater propensity to experience banking crises after local currency depreciation, and slower and more volatile output growth, without significant gains in domestic financial depth . The results indicate that active dedollarization policies may be desirable for many savings.”
More importantly, in a world with significantly higher geopolitical risks, a currency the basket mechanism becomes one of the best instruments (compared to national currencies) to reduce exposure to geopolitical risks and economic restrictions emanating from a single country or region. The reduction in geopolitical risks will be all the greater the more geopolitical heterogeneity there is in the basket of currencies. In this respect, a BRICS reserve currency is quite balanced because it brings together different countries like China and Russia on the one hand (with significant geopolitical competition with the West) and countries like Brazil and India on the one hand. on the other (significantly more cooperative relations with the West).
In order for new currencies to be more competitive internationally against “incumbent currencies” such as the US dollar, new entrants must carry a legal assertion of non-use of these currencies in sanctions or restrictive measures. Such depoliticization of new currencies would make them significantly more attractive to central banks amid elevated geopolitical risks. A non-sanction/depoliticization clause could be included in the charter/standards governing the new reserve currency. In the case of regional currencies, this can be undertaken by the respective Regional Financing Agreements (RFAs), while in the case of cross-regional projects such as the BRICS Reserve Currency, these standards must come from the Contingent Reserve Agreement of the BRICS (BRICS CRA) .
Therefore, the existing global currency represented by a basket of currencies – Special Drawing Rights (SDRs) – has the potential to significantly expand its presence in global foreign exchange reserves and currency transactions. It has the advantage of bringing together the most liquid currencies in the world, with the heterogeneity of the basket obtained by the inclusion of the four currencies of the advanced economies (USD, Euro, Japanese Yen and British Pound Sterling) as well as the Chinese yuan . The IMF, as regulator of the SDR, could potentially enhance its role in the global economy by allowing its use in international commercial transactions as well as increasing its appeal as a foreign exchange reserve instrument for central banks around the world. world. According to a prominent American economist Maurice Obstfeld, “denominating more global reserves in SDRs would affect exchange rate volatility between the major reserve currencies mainly insofar as it would reduce the potential shifts in official demand between these currencies. However, if more countries were to peg the SDR, their effective (and likely real) face value exchange rate volatility would fall”.
The IMF itself points to the tangible benefits of greater use of SDRs in the global economy, particularly in terms of reducing the volatility of financial market instruments: “M-SDRs [SDR-denominated financial market instruments] reduce currency and interest rate risk compared to single currency instruments, but there are some drawbacks and challenges. The nature of the M-SDR basket would allow the volatility of returns to be lower than that of a similar single SDR. monetary instrument”.
Similarly, the establishment of a BRICS reserve currency may well reduce volatility in the emerging market currency space, notably through the issuance of financial instruments with lower return volatility. The R5 could also serve as an important benchmark for other parts of emerging markets. Rather than peg to the US dollar or SDR, regional BRICS partners as well as other emerging economies could peg their currencies to the BRICS currency basket. The projects of new regional currencies currently carried by the regional blocs of the developing world (Latin America being an example) in line with the declarations of the President of Brazil Lula da Silva) could possibly be pursued on the basis of a basket mechanism and/or with the possibility of anchoring the new currency to the BRICS basket.
Ultimately, we are only at the beginning of what could turn out to be a marked expansion in the range of reserve currencies, with currency baskets potentially being among the most competitive and flexible instruments in the world. Mondial economy. These currency baskets may well include new regional currencies, if and when they emerge, as well as cross-regional currency baskets. The variety of combinations of these reserve currency platforms can greatly expand the optionality of reserve allocation for the world’s central banks. The future of the new international monetary system is paved with new reserve currencies.
From our partner RIAC