According to a number of press sources, Brazilian President Dilma Rousseff and Chinese President Xi Jinping spoke on the phone towards the end of June about “ways to strengthen policy coordination” in the context of recent US dollar appreciation. The exact details are likely to be worked out this month, when the BRICS finance ministers and central bank presidents meet in Russia.
This phone call is bigger news than it might initially seem. To understand why, some background may be instructive. As we know, in response to the financial crisis the US Federal Reserve (Fed) began a series of rounds of quantitative easing (QE) which have since retrospectively been compartmentalised into three rounds. The most recent, QE3, was nicknamed ‘infinity’ for what had seemed like its capacious open-endedness.
Emerging markets hit hardest by US Quantitative Easing
Quantitative easing (QE), which increases the monetary base – that is, the sum of currency in circulation – has been one of the key responses to managing the effects of the crisis. But its application is controversial, especially amongst emerging powers, due to its deleterious side-effects. Most obviously, an increase in supply of something is commensurate with a reduction in its value. Countries like China, with large reserves held in US dollars, have expressed concern at the potential reduction in value of these holdings.
There are other concerns. In a world where many countries have financial and currency markets open to the vicissitudes of global capital, flooding the system with more of a particular currency – especially if that currency happens to function as the global reserve – causes serious problems. At the height of QE, with the US dollar losing value, one clear effect was a rapid and corresponding appreciation in value of many currencies (Colombia, Mexico, Brazil), striking a sharp blow at the export-focused industries of these countries.
A key tenet of neoliberal doctrine has been the liberalisation of capital controls. Ironic, then, that those ‘emerging market’ countries which had most enthusiastically liberalised were often those hardest hit by QE.
Monetary policy in the North denounced as openly protectionist
Little surprise, perhaps, that when the first QE round began in September 2010, Brazil's outspoken finance minister, Guido Mantega, warned of an "international currency war." Some observers have been more specific, discussing this in terms of a war between rising and established powers that mirrors a wider North/South divide.
Mantega did not stand alone. In February this year, Chile’s finance minster called QE a “globally counterproductive policy”, adding: “One thing is unmistakably clear: the greatest share of the exchange rate adjustment costs resulting from quantitative easing is absorbed by a small group of developing and open economies, particularly in Latin America.”
A number of countries – including Brazil, China, Indonesia and India – attempted to take independent measures to combat the damaging effects of this currency appreciation. But they faced criticism (especially China) for this action from the US and its allies. Such measures were also uncoordinated, raising the prospect of damaging internecine struggles between the rising powers to control currencies.
Dilma Rousseff’s visit to Washington, DC in 2012 was dominated by this issue. Sitting next to Obama in the Oval Office, she told the press: “We expressed Brazil’s concern with the expansionary monetary policies in rich countries … which is leading to the depreciation of developed country currencies and compromising growth among emerging economies”. Earlier, she had denounced the monetary policy of the North as “openly protectionist” and promised “institutional measures to ensure that our internal market is not cannibalised”.
Risk of a balance-of-payments crisis
But while the implementation of QE has been problematic for rising powers, its slowing down could have even worse effects. Recent announcements by the Fed chairman, Ben Bernanke, that the massive US bond-buying programme could soon be contracted, have caused havoc: ‘nowhere as loudly as in emerging economies’, reports the FT.
One effect has been a serious sell-off in equities, bonds and commodities, especially harming the ‘rising power’ countries. Another effect has been the rapid depreciation of a number of currencies, including those of Russia, Brazil and India. This might seem to be a positive sign for these countries’ exports. But high levels of volatility make forward planning difficult and can, in the worst-case scenario, leave a national treasury with a disastrous balance-of-payments crisis.
The risk of a balance-of-payments crisis is higher in the context of current account deficits. A virtual checklist of ‘rising power’ countries are suffering from such deficits, including India, Turkey, South Africa, Brazil and Indonesia. India’s current account deficit has reached a record 6.7 percent, marking it as an especially vulnerable BRICS economy.
The Brazilian Finance Ministry’s reaction to this last month was to cancel the IOF tax on financial investment, which had been a response to the original quantitative easing; this has thus far had only limited impact. Last week, Finance Minister Guido Mantega pointed out that Brazil is restricted to having to wait for the US dollar to re-establish itself at a new exchange rate. It remains true that Brazil’s currency, “like all its peers, is basically up against the Fed’s might”, as Reuters reported last month.
Finance ministers in the South are unlikely to find much solace in suggestions that QE3 withdrawal could hit Europe hard too. And though it is true that, as Jim O’Neill has argued, the long-term economic outlook of the BRICS depends on factors broader than Fed policy, it remains the case that external shocks can have deep, lasting and unequal effects.
An emerging coordinated response amongst the BRICS?
Late last month, the World Bank President Jim Yong Kim discussed how the BRICS would suffer from QE rollback. Pointing out that the countries require an estimated $4.5trn for infrastructure development over the next five years, he added: “As quantitative easing slows down, the developing countries are really worried about access to capital.”
This is accurate, but only part of the picture. It is within the vital context of serious concern with the management of the global economy, and in particular with coordinated expansionary monetary policy in the North, that the BRICS have agreed to set up their own development bank and the Contingency Reserve Arrangement (CRA).
The CRA is a coordinated central bank fund which is set up to provide mutual liquidity in the event of a crisis – probably without the involvement of the IMF. Significantly, reports of last week’s phone conversation included mention of a discussion on speeding up the creation of the CRA.
The crisis recently engendered by the Fed’s announcement is already having a significant impact. Will an attempt by the BRICS to coordinate a response (pdf) to monetary policies in advanced industrial countries work? Given the sudden onset of the latest crisis phase, we may discover the answer to this question sooner than we had expected.
Musab Younis is a Research Officer on the Rising Powers in International Development programme at the Institute of Development Studies. You can follow Rising Powers on Twitter @IDSRisingPowers