Part three – Looking at the Fundamentals
DOUGLAS RASBASH
In part one the rationale of BRICS and of establishing a common currency called the Bric was explored and in part two how the Bric might work was discussed. In Part three we look at the economic and political fundamentals for a monetary alliance. It is very important for BRICS nations to learn from the Euro experience. The European Union nations decided to participate in the eurozone must meet requirements regarding price stability, sound public finances, the durability of convergence, and exchange rate stability. For this debt, balance of payments and inflation provide very good indicators.
Basic economic criteria
If BRICS members do not satisfy such basic economic criteria then the currency will surely fail. So how do the BRICS members comply with these very important criteria. The Gazette has prepared an analysis of the BRICS+ alliance of the original five plus twenty-four countries.
The debt-to-GDP ratios shown in the first figure is a measure of a country’s debt burden relative to its economic output. A high debt-to-GDP ratio indicates that a significant portion of a country’s economic activity is used to service its debt. It can be an important indicator because a lower debt-to-GDP ratio implies a higher capacity for a country to manage its debt payments over the long term, ensuring financial stability and reducing the risk of default. Countries with a lower debt-to-GDP ratio tend to have better credibility in financial markets, which can lead to lower borrowing costs and increased investor confidence. Lower debt levels indicate that a country is less vulnerable to external shocks, as it has more flexibility to respond to economic challenges and implement growth-enhancing policies.
From the chart, the countries with relatively high debt/GDP ratios are Venezuela (261.6%), Sudan (216.7%), and Zimbabwe (106.5%). The countries with moderate debt/GDP ratios include Argentina (96.1%), Turkey (87.4%), and Egypt (92.6%). The countries with relatively low debt/GDP ratios are Russia (13.4%), India (19.7%), and China (77%).
Balance of trade
The balance of trade reflects the difference between a country’s exports and imports of goods and services. A positive balance of trade, known as a trade surplus, occurs when exports exceed imports, while a negative balance of trade, known as a trade deficit, occurs when imports surpass exports. It is significant because a positive balance of trade indicates that a country is competitive in international markets, exporting more goods and services than it imports. This suggests a strong domestic industry and potential for sustained economic growth. A trade surplus can contribute to accumulating foreign exchange reserves, which are vital for currency stability and international transactions. Whereas a persistent trade deficit can lead to reliance on foreign borrowing and potentially put a strain on a country’s currency and overall economic stability.
With reference to the chart above, among the BRIC+ countries with positive average balances of payments are Iran (10.3 billion), Saudi Arabia (16.9 billion), and UAE (18.36 billion). Several countries have negative average balances of payments, including Brazil (-2.5 billion), Argentina (-2.5 billion), and Venezuela (-1.2 billion).
Inflation measures
Inflation measures the rate at which the general price level of goods and services in an economy is increasing over time. Low and stable inflation is generally preferred. The importance of inflation lies in promoting price stability, allowing businesses and consumers to make informed economic decisions without excessive uncertainty. Low inflation enables central banks to use monetary policy more effectively to stimulate or cool down an economy in response to economic conditions. High inflation can erode a country’s international competitiveness as it may lead to higher production costs and reduced export competitiveness.
Examining the chart above, it can be seen that Venezuela (2,300%) and Syria (225.86%) have extremely high inflation rates and other countries with relatively high inflation rates include Sudan (340.55%), Iran (36.47%), and Argentina (46.31%). Whereas China (0.1%), UAE (0.56%), and Bahrain (0.85%) have relatively low inflation rates. When considering the establishment of a currency or evaluating the economic health of member countries, these indicators provide insight into the countries’ fiscal discipline, economic resilience, and potential to contribute to a stable currency framework. However, it is important to note that many other factors, such as political stability, institutional strength, and economic integration, also play vital roles in determining the viability of an alternative global currency. Recognising this, an insight into the Euro should be of value.
Functioning currency
The Euro was created and has been functioning as a common currency for the Eurozone countries. The Euro has indeed played a significant role in facilitating trade, investment, and economic integration within the region. It has also provided stability and reduced currency exchange costs among member countries. It is worth considering the factors that have enabled the Euro to function as an alternative currency to the dollar. There is a strong political will between the twenty-six members of the EU. The member countries of the Eurozone demonstrated a strong commitment to European integration and monetary union. The political will to forge ahead with the Euro project helped overcome challenges and create a common currency. The Eurozone established institutions like the European Central Bank (ECB) to manage monetary policy and maintain price stability. The existence of a central bank dedicated to the common currency has played a crucial role in ensuring the credibility and stability of the Euro. The Eurozone introduced convergence criteria, such as debt/GDP ratios and inflation targets, to ensure participating countries had a certain level of economic stability before adopting the common currency. These criteria aimed to foster convergence and facilitate a smoother transition to a common monetary policy.
Eurozone countries
The Eurozone countries benefit from deep economic integration and a large internal market. This integration has increased trade flows, facilitated investment, and fostered economic growth within the region, contributing to the overall success of the Euro. The Eurozone has implemented crisis management mechanisms, such as financial assistance programs and fiscal coordination, to address challenges and support member countries in times of economic stress. These mechanisms have helped maintain stability and mitigate the impact of economic crises on the common currency. While the Euro has faced challenges and periodic crises, the commitment of member countries to the project and the implementation of measures to enhance stability have contributed to its resilience. However, it is important to note that the Eurozone’s experience also highlights the ongoing need for further integration, policy coordination, and reforms to address vulnerabilities and ensure the long-term viability of the common currency. Each currency union, including the BRICS or any alternative global currency, would face unique circumstances and challenges. Therefore, careful consideration of economic indicators, policy coordination, and political will are essential when assessing the feasibility and potential risks of creating a new currency union.
Non-economic criteria
Non-economic criteria play a crucial role in the success and sustainability of a currency union. While economic indicators provide important insights, several non-economic factors can significantly influence the feasibility and long-term viability of a common currency. These non-economic criteria may include political integration and a shared vision among member countries are fundamental for the stability and functioning of a currency union. A strong commitment to cooperation, shared governance structures, and decision-making processes are vital to ensure effective policymaking and crisis management. A robust legal framework is necessary to establish and govern a common currency. Clear rules and regulations regarding the central bank’s independence, fiscal discipline, enforcement mechanisms, and dispute resolution mechanisms help maintain trust and confidence in the currency union. The presence of strong and effective institutions is critical for the smooth operation of a common currency. Institutions such as a central bank, fiscal authorities, and regulatory bodies must possess the necessary expertise, independence, and accountability to effectively manage monetary and fiscal policies and ensure financial stability. The support and trust of the public are crucial for the success of a common currency. Public acceptance, understanding, and confidence in the currency and its governance mechanisms are essential to maintain stability and mitigate the risk of currency crises or withdrawals. Socio-cultural factors, including shared historical ties, cultural similarities, and language compatibility, can foster a sense of unity and cooperation among member countries.
Stronger integration and cooperation
These factors can contribute to stronger integration and cooperation in economic and monetary matters. The ability of member countries to adapt to changing economic conditions and external shocks is essential for the long-term viability of a currency union. Flexibility in terms of labour mobility, wage and price adjustments, and structural reforms can enhance resilience and promote economic convergence. A diversified and robust economic base across member countries helps mitigate risks associated with sector-specific shocks or economic imbalances. Economic diversification can enhance stability and resilience within the currency union. Considering these non-economic criteria alongside the economic factors can provide a more comprehensive assessment of the feasibility and potential risks of a common currency. It emphasizes the importance of broader integration, political cohesion, legal frameworks, institutional capacity, public support, and socio-cultural factors in ensuring the stability and success of a currency union. BRICS+ members need to work very hard indeed to satisfy the economic and the all-important non-economic exigencies to create a sustainable global monetary alliance and currency.