Dear friends,
Adding to the BRICS discussion, I would like to share with you some thoughts not on the BRICS development bank, but on the Reserve Fund the five countries also launched in their meeting in Fortaleza.
Prof. Dr. Barbara Fritz
Freie Universität Berlin
Economics Department/Latin American Institute
Ruedesheimer Str. 54-56, D-14197 Berlin, Germany
THE BRICS CONTINGENT RESERVE ARRANGEMENT IS A STEP
TOWARDS MORE FINANCIAL STABILITY
by Stephany Griffith-Jones[1], Barbara Fritz[2] and Marcos Antonio M. Cintra[3]
The volatility of international capital flows subjects emerging market currencies to boom and bust cycles. During the boom, capital inflows flood their financial markets. Financial assets and real estate appreciate, and exchange rates suffer upward pressure. The bust brings capital outflows and depreciates prices of assets and exchange rates. Interbank and capital markets retract; credit costs increase, debt rollover gets difficult, and credit transactions to foreign trade are disturbed.
When last year the Federal Reserve announced it would start softening its ultra-expansionist monetary policy, the currencies of most emerging markets, especially of India, South Africa and Brazil, went downwards. Central banks of emerging markets had to protect themselves against this tide with contractive monetary policy. From April 2013 to April 2014, the Central Bank of Brazil for instance raised the policy rate from 7.25% to 11%, one of the highest rates in the world in real terms.
This kind of policy not only lowers economic dynamism. It also creates new uncertainties, as a consequence of its impact on the fiscal balance and the accounts of firms and households. Even if these countries currently are far from being close to another financial crisis, they are forced to maintain capital inflows to finance their current account deficits. In 2013, the current account of Brazil registered a deficit in the current account of 2,4%, and India of 4,7% of GDP. Given this, capital flows have to be maintained, even at the cost of depressing the domestic economies.
What are the alternatives to face financial vulnerability? A significant devaluation of their currencies, followed by a period of stability, would not be a magic solution to every problem; however, it would certainly help regain competitiveness for exporters, thus improving the current account. However, how to accomplish a devaluation of such a magnitude without taking the risk of a cataclysm – capital flight and increasing interest rates, inflation and unemployment? Besides a domestic agreement to refrain transitory price increases, this would require support and coordination from outside. An international institution providing liquidity – guaranteed and supported by domestic reserves – would be required to support this process of controlled depreciation.
The IMF in its origins, back in the 1940s, has been set up to correct exactly this kind of imbalances; however, the Fund of today is far from playing this role. While a global solution is not on the horizon, better alternatives could be devised. Here, the BRICS have realized a double movement: the articulation of a common arrangement to protect against the instability of international capital flows, and the demonstration of solidarity among the major developing economies. At the BRICS summit in Fortaleza, they created a Contingent Reserve Arrangement (CRA) which pools $100 billion. China allocated $ 41 billion; Brazil, Russia and India, $ 18 billion each; South Africa, $ 5 billion (see the Full statement of the BRICS summit).
Each of these countries bears specific fragilities: Brazil, India and South Africa are listed among the 'fragile five', given their high current account deficits, low investment and GDP dynamism, together with increasing domestic prices and interest rates; China has been facing a certain economic slowdown and deleveraging of local governments and of its shadow financial system; Russia has been fighting capital flight. Nevertheless, they dispose of over $3,5 trillion of currency reserves. It is quite improbable that all these countries face external shocks at the same time.
It seems to be important that this mutual support comes without conditionalities (probably with the creation of a secretariat to provide the exchange of information and pursue mutual surveillance). The experience of the Latin American Reserve Fund FLAR comprising a group of Andean countries shows that a regional mechanism can provide liquidity with high speed – which is highly relevant in financial crisis – and without conditionalities. No member country ever defaulted on its debts with FLAR since the mechanism was founded in 1978.
Considering the role that each of these countries plays in its region, they could create and support similar tools of regional financial and monetary cooperation. These might range from bilateral swap arrangements or regional currency pools to payment systems which foster regional trade, among others (see also an UNCTAD study on “Regional momentary cooperation and growth-enhancing policies: The new Challenges for Latin America and the Caribbean”) This variety of defense mechanisms against abrupt shifts of global capital flows between the BRICS and their neighbors could contribute to reduce uncertainties and improve the governance of the international financial order.
For today, the creation of the BRICS currency reserve arrangement is a highly welcome step which should come to operate quickly. It has the ability to support the BRICS’ insertion into global markets, and helps to avoid austerity and deflationary policies in the more fragile of these economies.
[1] Initiative for Policy Dialogue at Columbia University. E-mail: <SGJ2108@Columbia.edu>.
[1] Institute for Latin American Studies at the Free University of Berlin. E-mail: <barbara.fritz@fu-berlin.de>.
[1] Institute for Applied Economic Research (IPEA), Brazil. E-mail: <marcos.cintra@ipea.gov.br>.
Adding to the BRICS discussion, I would like to share with you some thoughts not on the BRICS development bank, but on the Reserve Fund the five countries also launched in their meeting in Fortaleza.
Prof. Dr. Barbara Fritz
Freie Universität Berlin
Economics Department/Latin American Institute
Ruedesheimer Str. 54-56, D-14197 Berlin, Germany
THE BRICS CONTINGENT RESERVE ARRANGEMENT IS A STEP
TOWARDS MORE FINANCIAL STABILITY
by Stephany Griffith-Jones[1], Barbara Fritz[2] and Marcos Antonio M. Cintra[3]
The volatility of international capital flows subjects emerging market currencies to boom and bust cycles. During the boom, capital inflows flood their financial markets. Financial assets and real estate appreciate, and exchange rates suffer upward pressure. The bust brings capital outflows and depreciates prices of assets and exchange rates. Interbank and capital markets retract; credit costs increase, debt rollover gets difficult, and credit transactions to foreign trade are disturbed.
When last year the Federal Reserve announced it would start softening its ultra-expansionist monetary policy, the currencies of most emerging markets, especially of India, South Africa and Brazil, went downwards. Central banks of emerging markets had to protect themselves against this tide with contractive monetary policy. From April 2013 to April 2014, the Central Bank of Brazil for instance raised the policy rate from 7.25% to 11%, one of the highest rates in the world in real terms.
This kind of policy not only lowers economic dynamism. It also creates new uncertainties, as a consequence of its impact on the fiscal balance and the accounts of firms and households. Even if these countries currently are far from being close to another financial crisis, they are forced to maintain capital inflows to finance their current account deficits. In 2013, the current account of Brazil registered a deficit in the current account of 2,4%, and India of 4,7% of GDP. Given this, capital flows have to be maintained, even at the cost of depressing the domestic economies.
What are the alternatives to face financial vulnerability? A significant devaluation of their currencies, followed by a period of stability, would not be a magic solution to every problem; however, it would certainly help regain competitiveness for exporters, thus improving the current account. However, how to accomplish a devaluation of such a magnitude without taking the risk of a cataclysm – capital flight and increasing interest rates, inflation and unemployment? Besides a domestic agreement to refrain transitory price increases, this would require support and coordination from outside. An international institution providing liquidity – guaranteed and supported by domestic reserves – would be required to support this process of controlled depreciation.
The IMF in its origins, back in the 1940s, has been set up to correct exactly this kind of imbalances; however, the Fund of today is far from playing this role. While a global solution is not on the horizon, better alternatives could be devised. Here, the BRICS have realized a double movement: the articulation of a common arrangement to protect against the instability of international capital flows, and the demonstration of solidarity among the major developing economies. At the BRICS summit in Fortaleza, they created a Contingent Reserve Arrangement (CRA) which pools $100 billion. China allocated $ 41 billion; Brazil, Russia and India, $ 18 billion each; South Africa, $ 5 billion (see the Full statement of the BRICS summit).
Each of these countries bears specific fragilities: Brazil, India and South Africa are listed among the 'fragile five', given their high current account deficits, low investment and GDP dynamism, together with increasing domestic prices and interest rates; China has been facing a certain economic slowdown and deleveraging of local governments and of its shadow financial system; Russia has been fighting capital flight. Nevertheless, they dispose of over $3,5 trillion of currency reserves. It is quite improbable that all these countries face external shocks at the same time.
It seems to be important that this mutual support comes without conditionalities (probably with the creation of a secretariat to provide the exchange of information and pursue mutual surveillance). The experience of the Latin American Reserve Fund FLAR comprising a group of Andean countries shows that a regional mechanism can provide liquidity with high speed – which is highly relevant in financial crisis – and without conditionalities. No member country ever defaulted on its debts with FLAR since the mechanism was founded in 1978.
Considering the role that each of these countries plays in its region, they could create and support similar tools of regional financial and monetary cooperation. These might range from bilateral swap arrangements or regional currency pools to payment systems which foster regional trade, among others (see also an UNCTAD study on “Regional momentary cooperation and growth-enhancing policies: The new Challenges for Latin America and the Caribbean”) This variety of defense mechanisms against abrupt shifts of global capital flows between the BRICS and their neighbors could contribute to reduce uncertainties and improve the governance of the international financial order.
For today, the creation of the BRICS currency reserve arrangement is a highly welcome step which should come to operate quickly. It has the ability to support the BRICS’ insertion into global markets, and helps to avoid austerity and deflationary policies in the more fragile of these economies.
[1] Initiative for Policy Dialogue at Columbia University. E-mail: <SGJ2108@Columbia.edu>.
[1] Institute for Latin American Studies at the Free University of Berlin. E-mail: <barbara.fritz@fu-berlin.de>.
[1] Institute for Applied Economic Research (IPEA), Brazil. E-mail: <marcos.cintra@ipea.gov.br>.
