The dilemma that faces Bric economies today is about how to tailor their foreign exchange policy. Should they accord greater weight to capital inflows, welcome them but also risk inflation and higher real effective exchange rates (REERs)? Or, should they orchestrate policy to ward off inflows of that nature in order to maintain export competitiveness? These are the fundamental issues.
And these must actually be addressed amid the current context that comprises a volatile US dollar, a seemingly imperturbable Chinese yuan and outflows of US capital. The latter is fleeing Bernanke?s virtual zero interest rate regime, one that is central to his quantitative easing package (The Fed has lowered its benchmark rate to between 0.00% and 0.25%, pumped $2 trillion-plus into the financial system and directed banks to expand lending). Those actions have far-reaching implications precisely because 62% of the $7.3-trillion in forex reserves held by central banks and sovereign wealth funds (SWFs) currently are denominated in US dollars. Only 25% is in euros.
Yet, as recently as in September, World Bank chief Robert Zoellick did also caution the US against excessive smugness about the dollar?s pivotal status as reserve currency. He also identified the need for a ?multiplicity of the global reserve currency?, seeing that as a part of the shifting focus of global growth in the post-crisis era (one in which US consumers can no longer be relied on to be the sole engine of demand). Indeed, his caution?that there ?will be increasingly other options to the dollar??is a forecast that appears to be more convincing by the day.
Even reality seems to point that way. No less than three of the four Bric economies have decided to extend free rein to market forces vis-?-vis the dollar?and the currencies of all three are appreciating. Accordingly, we saw on November 20 that the Brazilian real, Russian rouble and Indian rupee each were reported to be well above their median-July 2009 rates against the dollar (see table). And that applies also to the Japanese yen and South Korean won. Yet, the real story is not about currency appreciation, but why?and how?China is using the yuan to remote control the US economy.
In short, China alone bucked the Bric?s general trend: it actually intervened to keep the yuan in step with a declining dollar. And, even when it allowed yuan to appreciate, that was just by a bare 00.1% between June 17 and November 20. (That is Beijing?s way of rendering yeoman service to all the multinationals that have invested in China to export.)
It is also ensuring that the Bric ? many of whom trade far less with the US ? do not get ?priced out? of world markets just because the dollar is falling. Beijing has been busy making alternative arrangements for its most intensely cultivated partners so that both can avoid the detour of the dollar turnpike. Thus, it has engaged in establishing currency swap arrangements with its major trading partners like Argentina, South Korea, Hong Kong, Indonesia, Malaysia and the Belarus. Russia, too, has agreed on rouble-and-yuan usage to conduct bilateral trade. And Beijing has been sketching out a similar real-and-yuan plan for Brazil as well. Such swap arrangements are enabling China to bypass currency markets and the dollar while trading with certain of its chosen interlocutors.
And an added attraction of such swap arrangements is that they are akin to ?all-route? visas. They allow the economies involved to use the yuan also to purchase goods and services from other countries included in China?s trade/currency-swap network. For instance, Argentina or Belarus can use surplus yuans, instead of dollars, to transact business with Indonesia or Malaysia. That, in effect, transports the yuan a major part of the distance towards attaining the status of reserve currency. And that will be as good as done if any one of the G-7 (i.e., G-8 minus Russia) also enters into a yuan swap arrangement. That is not at all far-fetched; note how Russia and South Korea have already fallen in line.
A final word on China could be that Beijing, apart from assuring its price competitiveness, is also actually helping the US by its policy of making the yuan move in lockstep with the dollar.
First, any departure from such a parity maintenance scheme would occasion yuan appreciation, making US imports from China more expensive in dollar terms, but not necessarily less competitive (as the price of competing domestic output, too, would start being pegged higher.) Secondly, the method by which China ensures a floor for the dollar also involves injections of liquidity into the US economy: that comes about when China undertakes mega-purchases of US treasury bills and debt instruments .
That means the US?s problems could become much worse if China ceases its dollar bailouts. That would start an erosion of liquidity in US money markets, ramp up the cost of credit?which, in turn, would be yet another stymie on the (very) recent revival of consumer demand. But that is unlikely to occur as long as Beijing understands that, in order to export, it also needs to keep its most committed customer on life support.
Something similar, in fact, is being done by India, too. It has started taking steps to free itself of the uncertainties engendered by the mercurial dollar. That is why it has started a serious assessment of the prospects for rupee-rouble trade. The real intent is to let trade with Russia flourish minus currency uncertainties, and as per the scheme enunciated very recently (in October) during the Hyderabad session of the Indo-Russian working group on banking and finance. That alone is expected to boost the Indo-Russian trade from its current $7 billion to $20 billion by 2015.
The writer is a fellow at the Maulana Abul Kalam Azad Institute of Asian Studies, Kolkata. These are his personal views