BRICs currency mechanism is impractical - analysts

By Ethel Hazelhurst Time of article published Apr 20, 2011

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At least one proposal to emerge from the meeting of the leaders of Brazil, Russia, India, China and South Africa at last week’s Brics summit is unlikely to bear fruit. In a joint statement after the meeting in China, the nations announced a study “in joint currency co-operation”.

The idea is to set up an exchange rate mechanism (ERM) between the five countries, effectively bypassing the world’s reserve currency, the US dollar.

Economists are puzzled by the proposal. Asked how the mechanism would work, Michael Power, a strategist at Investec Asset Management, said: “It beats me.” In answer to the same question, Brait economist Colen Garrow said: “Not at all. I don’t think it will.”

Power, who supports moves to weaken the rand, said he understood the bloc’s frustrations. Brics members have suffered from low interest rate policies in advanced economies, which led investors to redirect funds to emerging markets. This has boosted Brics currencies, making exports less competitive.

The bloc sees a five-member ERM as a device to achieve more stability. But Power said: “Cutting out the dollar middleman may reduce costs but is unlikely to reduce volatility.” And he described any attempt to agree on cross-rates and essentially create a five-way fixed rate sub-group as “a non-starter too as three out of the five (South Africa, Brazil and India) run current account deficits”.

A deficit forces countries to rely on foreign investment to finance their growth.

Garrow said the five Brics countries had very different exchange rate policies.

“The rand has been floating since the 1970s while China has a currency board.”

A currency board fixes rates, in contrast to allowing currencies to find their own level.

And Garrow pointed out the currencies of India, Brazil and Russia were not as liquid as the rand. Currencies are illiquid when they face a range of controls and when financial markets are relatively undeveloped.

Garrow said a Brics ERM would require policy co-ordination before it could work.

Relief may be in sight on the currency front. Power said the US Federal Reserve would start withdrawing excess liquidity mid-year, which would likely strengthen the dollar.

Reuters reported on Monday: “The Fed is on course to complete the purchase of $600 billion (R4 trillion) in US government debt by the end of June, which would take its total purchases of mortgage-related and government debt since December 2008 to nearly $2.3 trillion.” - Business Report

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