JOINT RESEARCH PAPER

USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Moscow RISS 2017 USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Authors Uallace Moreira Lima (Federal University of Bahia); Marcelo Xavier do Nascimento (Federal University of Pernambuco); Sergey Karataev, Nikolay Troshin, Pavel Zakharov, Natalya Gribova, Ivan Bazhenov (Russian Institute for Strategic Studies); Shekhar Hari Kumar, Ila Patnaik (National Institute of Public Finance and Policy); Liu Dongmin, Xiao Lisheng, Lu Ting, Xiong Aizong, Zhang Chi (Institute of World Economics and Politics, Chinese Academy of Social Sciences); Ronney Ncwadi (Nelson Mandela Metropolitan University); Jaya Josie (Human Sciences Research Council)

Editors Sergey Karataev, Nikolay Troshin, Ivan Bazhenov, Jaya Josie

Design and Publication Oleg Strizhak, Olga Farenkova (Russian Institute for Strategic Studies)

Abstract Financial crises of the past decades revealed the instability of the modern international monetary system based on a single dominant currency. Increasing the role and turnover of national currencies in international economic transactions and payments would contribute to redressing the existing imbalance. BRICS countries’ experience indicates that effi cient currency internationalization can be reached by both forming a number of prerequisites and fi nancial and economic policies pursued by the authorities. Strengthening the BRICS countries’ collaboration and implementation of joint initiatives should help create favorable conditions for promoting a wider use of their currencies in international settlements.

Keywords BRICS – Currency internationalization – Emerging markets – International monetary system – International settlements

Th e views expressed in this survey are those of the authors and do not necessarily represent the views of the Russian Institute for Strategic Studies.

ISBN 978-5-7893-0271-2 © Russian Institute for Strategic Studies, 2017

2 All rights reserved. Reproduction is authorised provided the source is acknowledged. Contents

Abbreviations and acronyms ...... 4 Executive summary ...... 7 Introduction ...... 10 Chapter 1. Theoretical Aspects of National Currencies’ Internationalization ...11 Chapter 2. The Recent Evolution of the Local Currency Payments System of the Brazilian Economy ...... 23 Chapter 3. Russia’s Deal on Promoting the Regional Status of the Ruble ....36 Chapter 4. Internationalization of the Indian Rupee ...... 57 Chapter 5. The Internationalization of RMB: China’s Experience ...... 76 Chapter 6. Towards National Currency Usage in International Transaction Settlements: Specific Experiences in BRICS — the Case of South Africa .....97 Conclusion ...... 109 USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

ABBREVIATIONS AND ACRONYMS

ADR American Depository Receipt AED United Arab Emirates dirham APAC Asia-Pacifi c ASEAN Association of Southeast Asian Nations BCB Brazilian Central Bank BIS Bank for International Settlements BRIC Brazil, Russia, India, China BRICS Brazil, Russia, India, China, South Africa BRIS Brazil, Russia, India, South Africa BRL Brazilian Real BYN Belarusian Ruble CIPS Cross-Border Interbank Payment System CIS Commonwealth of Independent States CISCA Collective Investment Schemes Control Act (South Africa) CMA Common Monetary Area CME Chicago Mercantile Exchange CNAE National Register of Economical Activities (Brazil) CNAPS China National Advanced Payment System CNY Chinese Yuan (Renminbi) COFER Currency Composition of Offi cial Foreign Exchange Reserves CRA Contingent Reserve Arrangement CSRC China Securities Regulatory Commission EAEU Eurasian Economic Union EBRD European Bank for Reconstruction and Development ECB External Commercial Borrowings EM Emerging Market EMDE Emerging Market and Developing Economy EU European Union EUR Euro FATF Financial Action Task Force FCS Federal Customs Service (Russia) FDI Foreign Direct Investment FED US Federal Reserve System 4 FEMA Foreign Exchange Management Act (India) FHC Fernando Henrique Cardoso, 34th President of Brazil (1995-2003) EXECUTIVE SUMMARY

FOB Free On Board FPI Foreign Portfolio Investment FX Foreign Exchange GBP Pound Sterling GDP Gross Domestic Product GFC Global Financial Crisis HK Hong Kong Special Administrative Region HVPS High Value Payment System (China) IEI International Economic Integration IFC International Financial Center IMF International Monetary Fund INR Indian Rupee IT Information Technology ITC International Trade Centre JPY Japanese Yen KRW South Korean Won LCY Local Currency LSE London Stock Exchange MCAP Market Capitalization MERCOSUR Southern Common Market (Mercado Comun del Sur) MICEX Moscow Interbank Currency Exchange MoF Ministry of Finance MP Monetary Policy MXN Mexican Peso NCM Common Nomenclature of the MERCOSUR NDC National Depository Center (Russia) NDF Non-Deliverable Forwards OTC Over-Th e-Counter PBC People's Bank of China QE Quantitative Easing RBI Reserve Bank of India RFDI Renminbi Foreign Direct Investment RMB Renminbi; see CNY RODI Renminbi Overseas Direct Investment ROW Rest of the World 5 RQDII Renminbi Qualifi ed Domestic Institutional Investor USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

RQFII Renminbi Qualifi ed Foreign Institutional Investor RUB Russian Ruble SA South Africa SAARC South Asian Association for Regional Cooperation SARS South African Revenue Service SARB South African Reserve Bank SDR Special Drawing Right SEBI Securities and Exchange Board of India SEZ Special Economic Zone SML Local Currency Payment System (Sistema de Pagamentos em Moeda Local) SOE State-Owned Enterprise SWIFT Society for Worldwide Interbank Financial Telecommunication TRY Turkish Lira UAE United Arab Emirates UK United Kingdom US United States (United States of America) USD US Dollar WDI World Development Indicator (World Bank) WTO World Trade Organization ZAR South African Rand

6 EXECUTIVE SUMMARY

Executive summary

1. Th e modern international monetary system based on the US dollar is being strongly criticized for its shortcomings. Th e US Federal Reserve᾽s monetary policy runs counter to the emerging market and developing economies’ monetary policy objectives aimed at controlling exchange rates, lowering infl ation and interest rates, and stimulating economic growth and employment. Financial systems in EMDEs frequently suff er the spillover eff ects of the US monetary policy that provokes capital infl ows/outfl ows. Research in this area resulted in a well-founded academic opinion pointing that risks of sudden USD liquidity drop may be smoothed by a wider use of national currencies in international settlements. 2. Using national currencies in international settlements presumes a long and com- plicated transition to their internationalization. Th at means a step-by-step promotion of a national currency as a unit of account, medium of exchange and store of value at the international level. A national currency becomes a unit of account when a foreign contract᾽s price is invoiced in such currency. It serves as a medium of exchange when fi nal settlements are made and as a store of value when non-residents purchase assets denominated in this currency. 3. Th e internationalization of a currency off ers some benefi ts to the issuing country, but also poses certain risks. As early as in the 1960s, R. Triffi n proved that infl ation risks are fostering, while a national currency᾽s share in international settlements is growing, thus jeopardizing its exchange rate stability and credibility among the global market participants. 4. To avoid negative consequences emerging in the course of internationalization, it is necessary to meet the following preconditions: — an issuing country should achieve a signifi cant share in the global economy and international trade (within its region, at least); — macroeconomic stability should be ensured, thus presuming predictability of the monetary policy, consistently low level of infl ation and mild exchange rate fl uctuations; — a country should have a well developed and liquid fi nancial market providing a wide range of FX and stock instruments; — foreign exchange regulations should be investor-friendly and not restrictive to in- ternational settlements in the national currency. 5. Monetary policy objectives and economic conditions in BRICS member states vary signifi cantly as do their strategies and results in promoting the internationalization of their local currencies. In this respect, the Chinese renminbi is ahead of the pack, e.g. in terms of interbank transfers turnover — its global share amounts to 1.68% as of December 2016 (recorded by SWIFT). Th e "top twenty" of currencies in this rating also include the South African rand (0.38%) and the Russian ruble (0.25%). Th e RMB᾽s share is also bigger than of other BRICS currencies in foreign trade turnover — it amounts to approximately 22% of the Chinese foreign trade volume. Th e Russian ruble follows closely behind (20%) — so that the two currencies are well ahead of the currencies of India, Brazil and South Africa. 6. Th e current state of internationalization progress by the BRICS currencies is linked both to above-mentioned preconditions and to fi nancial and economic policies pursued by their authorities. 7. China began promoting the RMB internationalization later than the other BRICS countries, but managed to achieve a bigger success. So, the IMF added the RMB to 7 the basket of SDR currencies from October 1, 2016. Th e pursuit by the government USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

of China of deliberate monetary policy objectives, with concomitant policy targets and instruments, was the driving force behind the Chinese accomplishments. Following the internationalization of the RMB, China experienced a currency depreciation and faced the confl ict between capital account opening and domestic fi nancial stability because of the capital outfl ow, forcing the country’s policymakers to make appropriate adjustments to capital account convertibility and the RMB internationalization. 8. Russia has opted for removing nearly all restrictions on the ruble᾽s transactions with non-residents (both current and capital accounts) by now. However, such measures have not yet proven benefi cial for widening its usage at the international level. Th e Russian experience has shown the limits and constrains of a partial internationalization exacerbated by the underdevelopment of fi nancial market and a country᾽s relatively small share in the world trade and economy. Th e Russian experience also demonstrates the risks of internationalization for macroeconomic stability caused by increasing vulnerability and exposure to external shocks. 9. Th e monetary authorities of three other BRICS countries have not yet managed to establish suffi cient prerequisites for a wide usage of their respective currencies in in- ternational settlements. Despite the formal permission to receive export proceeds in a national currency, the regulators in practice discourage market participants from making such payments. Regulators᾽ viewpoints on the subject are considerably aff ected by concerns about the US monetary policy᾽s spillovers emanating from possible interest rates hikes and following capital outfl ows from the developing economies. 10. India’s monetary authorities within the current macroeconomic framework focused on facilitating access to the internal FX market for non-residents and on developing the off shore bonds market denominated in Indian rupees. Th eir intention is to lower the foreign exchange requirements for servicing foreign debt and to promote the development of hedging market. Th ereby the preconditions for the gradual expansion of the usage of the Indian rupee in international settlements are being created in the long term. 11. Brazil presents an interesting example in respect to the internationalization of its currency. In 2009 the country was among the initiators and participants of the pioneering regional payment system — Sistema de Pagamentos em Moeda Local — created for settlements using local currencies in the region. At the time SML continues to operate smoothly and eff ectively in servicing the trade fl ows between Brazil and Argentina. However, its functioning is constrained by remaining foreign exchange restrictions and incomplete convertibility of the Brazilian real and the Argentine peso. Despite the small share of payments made under the system in relation to the total volume of bilateral trade, both countries keep being committed to using the SML. Moreover, in 2015 Uruguay joined this payment system, thus underscoring the importance of promoting intra-regional trade using national currencies to mitigate the risks of external and macroeconomic shocks emanating from the use of the US dollar. 12. Th e South Africa᾽s experience has clearly showed that even a relatively developed fi nancial market (the fi nancial assets to GDP ratio of the country exceeds the corresponding variables in all the other BRICS countries and are tantamount to advanced economy levels) does not completely safeguard from the problems inherent for a resource-based economy. Th erefore, further diversifi cation of the national economy is needed to ensure macroeconomic stability and enhance national currencies’ use in international settlements still more. 8 13. Th e BRICS countries’ experience presented in this report shows that a balanced development of all necessary and suffi cient preconditions have to be in place for a na- EXECUTIVE SUMMARY tional currency internationalization to establish the solid basis for its considerable share in international settlements. Nonetheless, even under the current situation of under- developed preconditions, the BRICS member states should continue discussing and developing policy targets and instruments in pursuit of widening the use of BRICS national currencies in international settlements for promoting the goal of increasing intra-BRICS trade, investment and economic cooperation. In particular, BRICS governments could consider multilateral policy instruments for removing administrative barriers and fostering fi nancial market development to promote wider use of national BRICS currencies in cross- border settlements within the pre-existing internationalization currency framework in the BRICS countries.

9 USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Introduction settlements in their local currencies1. Th e 2010 declaration was given greater urgency in the BRICS Ufa (Russia) Th e International Monetary Systems’ Summit Declaration of 2015, in which dependence on the US Federal Reserve’s leaders of the group acknowledged and monetary policy has always been a con- supported initial expert fi ndings that "the cern for EMDEs. Th ey are wary of the potential for expanding the use" of such negative spillover eff ects of the FED’s settlements in BRICS national currencies monetary policy that places the US was indeed a matter of importance for national economic interests above the promoting further economic and fi nancial interests of other countries. Aft er the cooperation among the BRICS member Asian crisis of 1997, EMDEs raised the states to mitigate current instability in the issue of extending the use of national international fi nancial system2. currencies to cover a wider spectrum Th is joint research paper prepared of international settlements. Th e glo- by experts and academics from the bal fi nancial crisis confi rmed their BRICS member states was undertaken concerns about risks emanating from to analyze the experience, and assess the US dollar’s dominant role in the the use of BRICS national currencies global economy and fi nancial markets, for international settlements. Th e First and induced strong reaction from the Chapter summarizes the results of international community which resulted theoretical studies on internationalization in a large number of policy researches of national currencies. Chapters 2—6 aimed at increasing the role and turnover present expert analysis of the current of national currencies in international state of BRICS currencies’ adaption to economic transactions and payments. international settlements. Th e Con- clusion summarizes the fi ndings of the With the BRICS countries’ signifi cant research, and proposes further steps for increase in their share of global GDP and consideration by the BRICS academic international trade during the 2000s, community, policy makers and public international fi nancial markets began to authorities. take a greater interest in their national currencies. Most of the BRICS countries have recently fully or partially lift ed the restrictions on foreign exchange transactions (at least with respect to cur- rent account transactions). Moreover, dynamic economic growth allowed the group member-countries to enhance macroeconomic stability and further develop their fi nancial markets. Th e need for measures to stabilize the international fi nancial system following the GFC was underscored at the 2nd BRIC Heads of State Summit 1 2nd BRIC Summit of Heads of State and held in Brasilia (Brazil) in 2010, where the Government: Joint Statement. 2010. April 15 // leaders of the group declared "a greater President of Russia: offi cial website. URL: http:// need for a more stable, predictable en.kremlin.ru/supplement/524 and diversifi ed international monetary 2 VII BRICS Summit. Ufa Declaration 10 // Offi cial website of Russia`s presidency in system" and showed their readiness to BRICS. 2015. July 9 URL: http://en.brics2015.ru/ study the possibilities of international load/381158 THEORETICAL ASPECTS OF NATIONAL CURRENCIES INTERNATIONALIZATION

Chapter 1

Theoretical Aspects of National Currencies’ Internationalization

International and services does not exceed 12% Monetary Systems (Figure 1). and settlements in Th e USD serves as a transmission mechanism of the US Federal Reserve’s national currencies monetary policy on the global economy and fi nancial markets. Th us, heavy Th e modern world economy is cha- reliance on the dollar in international racterized by an unparalleled level of settlements signifi cantly impairs the fi nancial services markets’ development, EMDEs’ monetary authorities’ ability to increase in cross-border investment fl ows counter external shocks and to achieve as well as integration of national and desirable targets of national monetary regional capital markets. Investors are policy. able to move huge amount of funds swift ly Th e FED’s interventions have led to from one country to another in search of diverse changes in global capital fl ows. the highest returns or "safe havens" for Th ey were directed to emerging markets periods of increased turbulence. as well as developing economies during Financial globalization is deeply aff ec- the periods of easing the United States’ ting the functioning of national fi nancial monetary policy and provided them systems. International capital fl ows’ fl uc- with excessive and cheaper liquidity. tuations may have a powerful impact on national markets. Th ey could lead to However, the tightening periods have had dramatic increases or decreases in assets the opposite eff ect and provoked sharp values, exchange rates and stock market and painful capital outfl ows resulting indices. Rising volume of international in emerging currencies’ depreciation, transactions creates additional challenges fi nancial fl uctuation and economic for regulators. It complicates the task of output decrease. Combating the GFC, the achieving targeted infl ation parameters, FED resorted to unconventional MP tools GDP growth and desired level of inte- dubbed "Quantitative Easing". A number rest rates. of studies have recently showed that the Th e reasons for drastic changes series of QE’s (1–3) have signifi cantly in capital fl ows and high volatility in increased the FED’s infl uence on the fi nancial markets lie in the fact that global fi nancial system (Gilchrist, Yue, the modern global fi nancial system is Zakrajsek, 2014). based on the US dollar serving as the In this situation, developing countries world currency. Most companies use are facing the challenge of fi nding ade- the USD as an intermediate currency for quate ways to neutralize the negative transactions with counterparties from eff ects of the global fi nancial cycle (Rey, foreign countries. According to SWIFT, 2013) and its waves of capital infl ow- 40.7% of international settlements are outfl ow. A natural solution to the pro- made in the USD while the United blem is through avoiding the excessive 11 States’ share in world trade in goods dependence on the USD by expanding USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Share of FX in the total amount of payments Share of country in global trade 45 40.7 40 35 32.9 30 24.2 25 20 15 12 13.7 10 7.5 5 3.8 3.1 3.7 1.9 2.4 1.7 1.5 1.8 0 United EurozoneUnited JapanCanada China Switzerland States Kingdom Figure 1. Shares of countries and currencies in global trade and in the total amount of payments, % Source: SWIFT. RMB Tracker, February 2017; WDI, World Bank

the circulation of national currencies in of protracted exchange rate misalign- international settlements. ments and persistent global imbalances Nakamura (Nakamura, Ueda, Matsui, would likely be reduced due to increasing 2012) specifi ed that the value of the USD policy discipline among the core and EUR fl uctuated wildly during the economies. global fi nancial and debt crises in 2008, Even a number of prominent US ana- and shortfalls of liquidity frequently lysts (Bergsten, 2009) are now arguing arose. Although the impact from fl uc- that the dollar’s global dominance is tuations in these currencies could not no longer in the national interest of the be completely eliminated, the use of a United States, and they have urged the home country currency or more direct US government should explore ways of transactions in currencies other than the "downsizing" the dollar’s international USD and EUR may reduce impacts in role. Th ey have expressed concerns the event of similar crises in the future. about how the dollar’s international Furthermore, Nakamura opined that role undermines the US export com- alleviating exchange rate fl uctuation petitiveness, contributes to the country’s risk for emerging countries through a payments defi cits and increases the currency’s internationalization could country’s vulnerability to overseas offi cial contribute to stability of EM’s fi nances dollar holders. and to extension of international fi nance. Th e IMF experts denote that limited Th e dominant role of the USD creates role of EM currencies in international problems for the entire global fi nancial transactions stands in sharp contrast system, especially for developing coun- to their growing weight in the global tries. Specifi cally, it was emphasized economy, which is in itself a source 12 in certain studies made by the IMF of stress to the functioning of the experts (IMF, 2011). Th ey consider international monetary system (IMF, that in a multipolar system the risk 2011). While fi nancial fl ows continue THEORETICAL ASPECTS OF NATIONAL CURRENCIES INTERNATIONALIZATION

Table 1 Roles of an international currency

Function of money Governments Private sectors Currency substitution and Store of value International Reserves investment Vehicle currency for FX Invoicing trade and fi nancial Medium of exchange intervention transactions Anchor for local currency Denominating trade Unit of account pegging and fi nancial transactions Source: Based on Chinn and Frankel (2008) to be dominated by advanced economies, but also, and importantly, for transactions in the longer run, EM currencies show between non-residents. potential to achieve wider international According to Nakamura’s defi nition, use similar to some advanced economies. internationalizing does not necessarily For instance, currencies of commodity mean expanded usage throughout the exporters (e.g., the Russian ruble and the entire world, but rather usage spanning Brazilian real) could play larger regional borders and among countries and regions roles and become part of reserve assets with strong economic interdependence. similar to the Australian or Canadian As such, the internationalization of a cur- dollar; while the RMB could achieve rency does not mean that a currency global use due to the economic size and becomes a key currency. trade-related centrality of the Chinese Chinn and Frankel have developed economy. a framework based on international According to the IMF executives, the functions of a currency to determine the greater use of multiple currencies has level of its internationalization. Table 1 the potential to diversify risks, enable gradual global adjustments, and provide shows the various roles of an internatio- incentives for sustainable policies. It nal currency in private and offi cial sector. can also help creating a more stable National currency may be used as a environment for capital fl ows — thus unit of account where a foreign contract’s enhancing systemic stability. Th is can be price is denominated in such currency achieved by reducing tensions between (invoicing currency) or invoice is issued domestic policies in reserve-issuing in such currency (account currency). countries and the liquidity needs of the National currency may serve as a medium global economy (Furusawa, 2017). of exchange if a contract (e.g. dollar- denominated) is paid using a diff erent What is currency currency (settlement currency). However, internationalization? an invoicing currency is more important because settlements (payments) may Th ere is a well-established literature actually be made in any currency using to denote the meaning of a currency exchange rate at the payment date. internationalization (Eichengreen and National currency may also act as a store Flandreau, 2012). According to Kenen of value when it is used for purchase of (2011), an international currency is one assets (primarily securities) denominated that is used and held beyond the borders in this currency. of the issuing country, not merely for According to Kenen (2011), nati- 13 transactions with that country’s residents onal currency may be recognized as USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

internationalized when most of the fo- process and may go on without full llowing conditions are met. implementation of the Kenen conditions. 1. Th e government must remove all Of course, the more functions a national restrictions on the freedom of any currency performs in the international entity, domestic or foreign, to buy level, the higher its attractiveness is as or sell its country’s currency, whether an invoicing currency. However, it may in the spot or forward market. merely act as a settlement currency 2. Domestic fi rms are able to invoice without necessarily being acclaimed as some, if not all, of their exports in a reserve currency — i.e. without being their country’s currency, and foreign widely deposited in international reserves fi rms are likewise able to invoice their of other countries. exports in that country’s currency, whether to the country itself or to Benefits and third countries. risks of currency 3. Foreign fi rms, fi nancial institutions, offi cial institutions and individuals are internationalization able to hold the country’s currency and fi nancial instruments denominated in Currency internationalization has not it, in amounts that they deem useful always been seen as a benefi t for the and prudent. issuing country. In a number of cases, 4. Foreign fi rms and fi nancial instituti- fi nancial authorities deliberately limited ons, including offi cial institutions, are using their currency abroad (e.g. China able to issue marketable instruments before the GFC). in the country’s currency. Th e Western countries have, at 5. Th e issuing country’s own fi nancial times, also tried to discourage the use of institutions and non-fi nancial fi rms the domestic currency internationally are able to issue on foreign markets because of the perceived costs that may instruments denominated in their be associated with such use. For example, country’s own currency. during the time when the Deutsche 6. International fi nancial institutions, Bundesbank and the Swiss National Bank such as the World Bank and regional focused their monetary policy strategies development banks, are able to issue on the control of monetary aggregates, debt instruments in a country’s there was fear that greater international market and to use its currency in their use of the Deutsche mark or the Swiss fi nancial operations. franc would render the demand for money 7. Th e currency may be included in the less stable and therefore complicate the currency baskets of other countries, setting of the appropriate target growth which they use in making their own rate for the supply. It may also be argued exchange rate policies. that international use of the currency It should be noted that implementation could render the exchange rate more of the fi rst paragraph presumes the volatile and therefore complicates the complete revocation of foreign exchange task of fi nding the appropriate level of the restrictions. In the case of remaining policy interest rates (Genberg, 2011). barriers for capital account transactions, However, the USD dominance in the internationalization may develop foreign trade payments, loans and inve- mainly by increasing the share of national stments has been recently viewed as a currency in bilateral trade settlements. factor of vulnerability that is desirable to be reduced. As a result, many countries 14 Th us, the use of national currency in international settlements constitutes set a goal of decreasing dependence a section in its internationalization on the USD in foreign settlements THEORETICAL ASPECTS OF NATIONAL CURRENCIES INTERNATIONALIZATION and expanding the use of their national international debt in more competitive currencies. terms. But they note that this may also Now the common view is that the complicate monetary management and internationalization of a national currency strain the domestic fi nancial system’s brings important benefi ts to the issuing ability to absorb capital fl ows due to country. Eichengreen et al. (2015) explain potential for increased volatility and large that internationalization of a national shift s in portfolio fl ows (IMF, 2011). currency would (1) reduce exchange Genberg (2011) argues that the benefi t rate risks for the country’s enterprises, of currency internationalization to the (2) reduce the need for holding more issuing country is the seigniorage gains foreign exchange reserves, (3) promote associated with the additional demand trade by reducing transaction costs, for the physical currency. Th e benefi t and (4) improve the competitiveness of to the user includes a relatively high the currency-issuing country’s fi nance real value of a readily accepted note sectors. (e.g. the USD 100 bill), the widespread Nakamura (2012) opines that inter- international acceptance of the currency nationalization of a currency off ers for transactions, and the relative stability several merits for the home country in as a store of value. He also notes that full terms of private sector economic activity. and partial currency internationaliza- 1. Reduces the risk of exchange rate tion can reduce borrowing costs due fl uctuations in trade. Companies to the larger size of the market for debt bear less risk of exchange rate denominated in a particular currency and fl uctuations particularly when trade to the potential diversifi cation gains. and settlements are conducted in the Th e establishment and liberalization currency of the home country. of domestic markets improve the 2. Makes fi nancial institutions more competitiveness of fi nancial institutions competitive internationally. Th e com- by promoting open and competitive petitiveness of fi nancial institutions markets, and this strengthens the ability strengthens when the home country of domestic fi nancial and capital markets currency is used more widely in to handle expanded capital infl ows and fi nancial transactions. Under these outfl ows anticipated aft er the currency circumstances business opportunities becomes more international. are likely to increase. Furthermore, Despite the benefi ts promised by in- liquidity risk related to raising funds ternationalization, central banks of deve- in foreign currencies is alleviated for loping countries are wary of lift ing fi nancial institutions as a country’s restrictions on transactions of non- currency internationalizes. residents with national currency. Th is 3. Contributes to the development of is because the international status of a the country’s fi nancial and capital currency brings not only benefi ts, but also markets. certain obligations and vulnerabilities 4. Internationalized currencies are also (Helleiner, 2013). advantageous during extraordinary Large amount of a national currency times. Th e impact of exchange rate begins to circulate abroad as it is being fl uctuations against key currencies internationalized. As a result, the na- like USD and EUR as well as other tional fi nancial system is exposed major currencies diminishes. to certain risks, i.e. the central bank Th e IMF experts agree that benefi ts will loosen its control over monetary from internationalization include poten- parameters, so that not only demand but tially lower transaction costs and reduced also supply of the currency will to some 15 exchange rate risk, and the ability to issue extent be governed by non-residents. USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Such allegation regarding the USD was needs confi dence in both the value of its specifi ed by R.Triffi n in the early 1960s, currency and the political stability of the when he formulated his famous paradox country concerned. And secondly country (Th e Triffi n Dilemma). He noted that should maintain the convertibility of the USD stock is limited by the amount its own currency. It should also possess of the United States gold reserve. At the well-developed fi nancial markets; broad, same time, the dollar should be emitted in that they contain a large assortment in volumes that meet the needs of the glo- of fi nancial instruments; deep, in that bal trade. they have well-developed secondary It is well known that the paradox led markets; and free of controls on fi nancial to the Bretton Woods system’s collapse. transactions. Despite the demonetization of gold, Th e breadth and depth of the nati- the Triffi n Dilemma remains relevant onal fi nancial market is a necessary even nowadays both for the USD and benchmark indicator of the ability of a for any other currency in the process of currency to be utilized as an international internationalization. An issuing country currency. However, it is not a suffi cient must have a balance of payments defi cit condition to achieve this status as other in order to provide participants of inter- factors play equally important roles as national trade and investments with was demonstrated in the fi nal ascension suffi cient stock of a currency. At the same of the Chinese renminbi to international time, a constant and/or growing ba lance reserve currency status in 2016 aft er many of payments defi cit causes increasing years of trying. infl ationary expectations that undermine Nakamura (2012) specifi es that confi dence in the national currency and there are two main preconditions for a lead to its depreciation. currency to internationalize. One is the Historical experience shows us that development of a country’s economic the dilemma cannot always been avoided. activities, particularly outward trade, Successful internationalization of a nati- to a certain level within the world or a onal currency presumes the existence of given region. In order for this to happen, certain preconditions. economic mutual dependence with the relevant region must increase and cross- Prerequisites border transactions — current account for currency transactions and capital transactions — internationalization must expand. Th e second precondition is the ab- Th ere is an academic consensus that sence of restrictions or regulations in success of a currency internationalization usage of a country’s currency in activities; is impossible without the following factors: that is, the liberalization of the currency. a currency-issuing country must have Furthermore, in order for a currency to a considerable volume of international be used by the economic entities of other trade; its share in global trade must be countries, domestic fi nancial and capital substantial; appropriate infrastructure markets must be equipped and open in (a developed banking sector, highly liquid order for economic entities both within fi nancial markets etc.) must be available and outside the country to make fi nancial for international participants. and capital transactions. Specifi cally, Tavlas and Ozeki (1992) and Tavlas (1) interest rates and fi nancial services (1992) postulate that a currency to must be liberalized; (2) interest rate and 16 gain reserve status must meet the exchange rate futures markets must be following preconditions. First, there established; and (3) short-term fi nancial THEORETICAL ASPECTS OF NATIONAL CURRENCIES INTERNATIONALIZATION markets and bond markets must be In other words, the more economic agents nurtured. use this currency in settlements, the more Genberg (2011) postulates that inter- oft en it will be used by others. nationalization of a currency needs In particular, the USD is more essential some pre-requisites as follows, (1) no compared to other currencies because restrictions on cross-border transfers of of the ability to aff ect signifi cantly more funds, (2) no restrictions on third party transactions. Th is can be explained by use of the currency in contracts and scale economy due to the huge number settlements of trade in goods or assets, (3) of operations performed with the USD. no restrictions on transactions of assets It leads to a reduction in spreads between denominated in the currency in private or the quotations for buying and selling the offi cial portfolios, (4) existence of a deep USD as well as reduction in bank transfer and dynamic domestic fi nancial market, fees. As a result, the US currency pro- (5) a well-respected legal framework for vides an exporting company with lower contract enforcement, (6) stable and transaction costs. predictable macro and micro-economic Of course, even if all the prerequisites policies. are met, there is no guarantee that Cohen (2012) recites four economic currency internationalization will spon- determinants for internationalization. taneously follow. Genberg (2011) notes First, currencies are more likely to that economies of scale in the use of an be used internationally if foreigners international currency suggest that the have confi dence in their stable value, world can sustain only a limited number a confi dence usually cultivated by a of international currencies. record of low and stable infl ation as IMF experts underline that only well as a steady external value. Second, a few EM currencies, led by the international currencies are usually Chinese renminbi, show potential for characterized by "exchange convenience" internationalization on a global scale, and "capital certainty" because they albeit many more could achieve some can be held in liquid fi nancial markets degree of international use. In their that are broad, deep, resilient and open opinion, economic size — including to foreigners. Th ird, support by broad trade networks — macroeconomic stabi- transactional networks, stemming from lity, and policy support are impor- the issuing country’s prominent size in tant determinants of currency interna- the world economy. tionalization (IMF, 2011). Economic inertia is the fourth factor Eichengreen, Hausmann and Panizza that can sustain the international role (2002 and 2003) advocate the hypothesis of a currency. When a well-established known as "original sin", according transactional network already exists, the to which the international monetary switching of currencies can be econo- system is characterized by asymmetries mically costly. Cohen argues that inertia among the currencies of peripheral and may also be a product of conservative and central countries. Most countries are risk-adverse behaviour among economic unable to issue debt in local currencies actors when faced with uncertainties in the international market and also involved in choosing an alternative do not produce fountains of long-term currency. fi nancing in domestic markets, so they Such inertia is based on network ex- are constrained to borrowing in major ternalities that can be defi ned as addi- foreign currencies, especially USD. As a tional value received by a benefi ciary where result, these countries are characterized the total number of such benefi ciaries by elevated degree of volatility of their 17 has increased (Katz and Shapiro, 1985). fi nancial markets, fl ows of capitals USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

and also limited degree of autonomy of and cannot be traded between third their respective monetary policies. parties. Th e authors explain the elevated Empirical observations also indicate volatility and macroeconomic instability that an increasing number of new of developing countries by the following currencies are entering international factors. fi nancial markets. Th ere is a general 1. Limited capacity of authorities to growth in the turnover of these markets undertake countercyclical policies. including through securities denominated 2. Low capacity of the central bank to in "exotic" currencies. carry out one of its basic functions — Summarizing the international to act as a lender of last resort (because studies’ experience, we can state that for much liabilities are in USD). the wider use of a national currency in 3. Dollar-denominated debt increases international settlements, it is necessary the costs of currency depreciations, to work in the following fi elds. which, in the event of a currency 1. Foreign trade. Th e development crisis, may lead to large falls in out- of payments in national currencies is put. To address this fragility issue, possible between countries that have a governments are forced to accumulate signifi cant amount of mutual trade. Th is big foreign reserves to intervene in will allow exporters and importers to the foreign exchange market in order accumulate foreign exchange when they to prevent a national currency from deal with their foreign counterparties, and then invest it in goods, services moving and/or to enable it to act as and fi nancial instruments of partner debt servicer of last resort in moments countries. of reversion of the economical cycles 2. Financial markets. Companies and capital outfl ows. should be able to purchase/sell a currency Th at implies some kind of hierarchy of quickly and without additional costs to currencies in the international monetary make settlements in such currency. Th is system. It is hard for any new currency to presumes the existence of highly developed get fully internationalized, because it has and liquid interbank and forex markets to crowd out some other currency from with large numbers of participants and portfolio of global fi nancial investors. convertible fi nancial instruments. Along Each successful country raises the bar with this, it is necessary to develop a deep to others, insofar as the addition of its and liquid stock market that is able to securities to the global portfolio will absorb temporarily cash liquidity. reduce the diversifi cation benefi ts of ad- 3. Foreign exchange regulation. It is ding yet another currency (Eichengreen, important to create a favorable legal and Hausmann and Panizza, 2002 and 2003). regulatory environment supporting the However, many authors oppose wider use of a national currency in cross- such determinism regarding the border transactions as well as to remove limitation of the number of currencies restrictions and barriers to foreign in the international fi nancial market. exchange transactions. Agreements with In particular, Genberg (2011) notes other countries are also required to ensure growing opportunities for partial the implementation of relevant fi nancial internationalization in the present transactions (payment agreements, swap context. Many countries increasingly lines etc.). provide access to their debt markets 4. Maintenance of macro-economic (e.g. public bonds) for foreign investors, 18 stability is perhaps the most important even though these securities are not precondition. Stable economic growth, convertible in the international market predictable monetary policy, consistently THEORETICAL ASPECTS OF NATIONAL CURRENCIES INTERNATIONALIZATION low infl ation expectations and high level works of Bachetta (2002) and Goldberg of confi dence in the national currency (2005). provide better opportunities for its wider An important independent result use in international settlements. of Goldberg was the conclusion that exporters of similar goods, such as oil Factors affecting the or iron ore, will seek to establish the choice of settlement contract price in the same currency as currency their competitors. Th at allows them to neutralize more successfully the adverse Th e IMF experts opine that speed and exchange rate fl uctuations resulting in shape of progress toward a more multi- considerable price changes and therefore currency system will be largely market- prevent the risk of reducing demand. As driven, but there is also a scope for a result, the market price of such goods policy action to facilitate this transition is denominated mostly in the US dollar. (IMF, 2011). Domestic policies could According to the authors, the global support the creation of prerequisites for commodities exchange trade in these currency internationalization (such as goods plays a signifi cant role. Th ey argue macroeconomic stability and fi nancial that if the global commodities market’s markets’ depth) and help building of impact on the pricing model will decrease, market infrastructure. At the same time, the use of the USD as invoicing currency it is necessary to take into account that in will decline too. addition to macroeconomic conditions, Industry infl uence factor on the there are also a number of microeconomic choice of invoicing currency is clearly factors infl uencing private corporative demonstrated by the Australian sta- choice of an invoicing currency. tistics. For instance, 99.2% of the It has been presumed under economic contracts purchasing iron ore, 99.9% — theory that exporters prefer their coal and 88.9% — natural gas supplied national currency for trade invoicing from Australia in the fi scal year of (so-called Grassmann’s law). Th at can 2015/2016 were invoiced in the USD. be explained by the exporter’s desire At the same time, only 29.6% of to mitigate exchange risks. However, it has been discovered that in the case medicine and pharmaceutical products’ of fl oating exchange rates regime, the exports, 30.1% of general engineering supplier’s currency choice is aff ected not products and 55.4% of road vehicles 1 only by this desire but also by consumers’ were denominated in the USD . Th us, demand and by prices level ratio between the higher variety of supplied goods external and internal markets. According (e.g. such as products of engineering or to Donnenfeld and Zilcha (1991), it pharmaceuticals), the more opportunities may be more profi table for an exporter for companies to denominate the price to denominate contract price in the in national currency without fear of currency of importing country — in a case fl uctuations in demand. Th at is because of signifi cant decrease in demand caused 1 See International Trade in Goods and Services, by prices increase due to unfavorable Australia, October 2016 // Australian Bureau of changes in the currency exchange rates. Statistics. URL: http://www.abs.gov.au/AUSSTATS/ Th e correlation between a choice of [email protected]/Previousproducts/5368.0Feature%20 Article1Oct%202016?opendocument&tabnam 19 invoicing currency and price elasticity e=Summary&prodno=5368.0&issue=Oct%20 of demand was confi rmed later in the 2016&num=&view= USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

diff erent brands of goods are perceived London Metropolitan University. 2015. by consumers as independent products. No. 28. URL: http://www.gpilondon.com/ A similar situation occurs in the case wp-content/uploads/PP28-The-New- of imports. However, the commodities- BRICS-Bank.pdf dominated orientation of Australian 6. Donnenfeld S., Zilcha I. Pricing of exports leads to the low share of national Exports and Exchange Rate Uncertainty currency — it does not exceed 15% in the // International Economic Review. 1991. exports compared with more than 31% in Vol. 32. No. 4. P. 1009–1022. the imports. 7. Eichengreen B., Chitu L., Mehl A. High exchange rate fl uctuations Stability or Upheaval? Th e Currency should be named among other factors that Composition of International Reserves determine an entity’s choice of currency. in the Long Run // European Central Exporters will seek to denominate their Bank. Working Paper. 2014. No. 1715. contracts in foreign exchange when their URL: http://www.ecb.europa.eu/pub/pdf/ national currency is devaluing. It will scpwps/ecbwp1715.pdf?485e29e6bbcff 968 allow them to receive additional profi ts in 4dfb 4cc545b2aefc the national currency. At the same time, 8. Eichengreen B., Flandreau M. Th e importers shall be encouraged to invoice Federal Reserve, the Bank of England, and a contract price in their national currency the rise of the dollar as an international in order to reduce costs and prevent currency, 1914–39 // BIS. Working Paper. a decline in demand as a result of rising 2010. No. 328. URL: http://www.bis.org/ prices. publ/work328.pdf Th us, development of internal competition together with fostering of a 9. Eichengreen B., Hausmann R., highly diversifi ed range of export products Panizza U. Currency mismatches, debt help expanding the use of a national intolerance and original sin: why they are currency in international settlements. not the same and why it matters // National Bureau of Economic Research. Working References Paper. 2003. No. 10036. URL: http://www. nber.org/papers/w10036.pdf 10. Eichengreen B. Number One Coun- 1. Bachetta P., van Wincoop E. A Th e- try, Number One Currency? // Th e World ory of the Currency Denomination of Economy. 2013. Vol. 36(4). P. 363–374. International Trade // European Central Bank . Working Paper. 2002. No. 177. 11. Eichengreen B., Hausmann R., Panizza U. Original sin: Th e Pain, the 2. Bergsten C. F. Th e Dollar and the Mystery and the Road to Redemption. Defi cits: How Washington Can Prevent Conference “Currency and Maturity the Next Crisis // Foreign Aff airs. 2009. Matchmaking: Redeeming Debt from Vol. 88. No. 6. P. 20–38. Original Sin”. Washington, D.C. 3. Chinn M., Frankel J. Why the Euro 2002. November 21–22. URL: http:// Will Rival the Dollar // International Fi- www.financialpolicy.org/financedev/ nance. 2008. No. 11(1). P. 49–73. hausmann2002.pdf 4. Cohen B. J. Th e Benefi ts and Costs 12. Furusawa M. Strengthening the of an International Currency: Getting the International Monetary System. IMF Calculus Right // Open Economies Review. Deputy Managing Director Remarks 2012. Vol. 23. No. 1. P. 13–31. to a Conference on the Future of 5. Dixon C. Th e New BRICS Bank: International Monetary System for 20 Challenging the International Financial Asia. 2017. March 8. URL: http://www. Order? // Th e Global Policy Institute. imf.org/en/News/Articles/2017/03/08/ THEORETICAL ASPECTS OF NATIONAL CURRENCIES INTERNATIONALIZATION

SP030817-Strengthening-the- 2011. No. 61. P. 9–18. URL: http://www. International-Monetary-System bis.org/publ/bppdf/bispap61.pdf 13. Gao H., Yu Y. Internationalization 20. Lee J.-W. Will the renminbi emerge of the renminbi // Currency inter- as an international reserve currency? // Th e nationalisation: lessons from the global World Economy. 2014. Vol. 37. P. 42–62. fi nancial crisis and prospects for the future 21. Maziad S., et al. Internationalization in Asia and the Pacifi c // BIS. BIS Papers. of Emerging Market Currencies: A Balance 2011. No. 61. P. 105–124. URL: http:// between Risks and Rewards // IMF. Staff www.bis.org/publ/bppdf/bispap61.pdf Discussion Note. 2011. No. SDN/11/17. 14. Genberg H. Currency interna- URL: http://www.imf.org/external/pubs/ tionalisation: analytical and policy issues ft /sdn/2011/sdn1117.pdf // Currency internationalisation: lessons 22. Nakamura A., Ueda K., Matsui K. from the global fi nancial crisis and Th e Internationalization of Emerging Eco- prospects for the future in Asia and the nomy Currencies: Some Th oughts on Pacifi c // BIS. BIS Papers. 2011. No. 61. P. the Internationalization of the Chinese 221–230. URL: http://www.bis.org/publ/ Renminbi, Brazilian Real, and Russian bppdf/bispap61.pdf Ruble // Institute for International 15. Gilchrist S., Yue V., Zakrajsek E. Monetary Aff airs. International Economic and Financial Review. 2012. No. 2. URL: U.S. Monetary Policy and Foreign Bond http://www.iima.or.jp/Docs/report/2012/ Yields. IMF 15th Jacques Polak Annual no2_2012_e.pdf Research Conference. 2014. November 11. URL: http://www.imf.org/external/np/res/ 23. Ranjan R., Prakash A. Internatio- seminars/2014/arc/pdf/gilchrist.pdf nalization of Currency: Th e case of the Indian Rupee and Chinese Renminbi // 16. Gopinath S. An Internationalised Reserve Bank of India Report. RBI Staff Rupee? // BIS. 2009. URL: http:// www.bis. Studies. 2010. No. 3. URL: http://rbidocs. org/repoffi cepubl/arpresearch200903.10. rbi.org.in/rdocs/PublicationReport/Pdfs/ pdf RRSS180510F.pdf 17. Helleiner E. Reluctant Monetary 24. Renminbi internationalization: Leaders? // Th e BRICS and Asia, Currency Achievements, prospects and challenges / Internationalization and International B. J. Eichengreen, M. Kawai (eds.) // Monetary Reform // Asian Development Asian Development Bank Institute. Bank. Working Paper. 2013. No. 6. URL: Brookings Institution. Tokyo, 2015. http://www.adb.org/sites/default/files/ URL: http://www.adb.org/sites/default/ publication/30198/brics-asia-paper-no6. files/publication/159835/adbi-renminbi- pdf internationalization-achievements- 18. Ito T. A New Financial Order in prospects-challenges.pdf Asia: Will a RMB bloc emerge? // National 25. Rey H. Dilemma not Trilemma: Bureau of Economic Research. Working Th e Global Cycle and Monetary Policy Paper. 2016. No. 22755. URL: http://www. Independence // National Bureau of nber.org/papers/w22755.pdf Economic Research. Working Paper. 19. Kenen P. Currency internationa- 2016. No. 21162. URL: http://www.nber. lisation: an overview // Currency inter- org/papers/w21162.pdf nationalisation: lessons from the global 26. Shu C., He D., Cheng X. One cur- fi nancial crisis and prospects for the future rency, two markets: the renminbi’s 21 in Asia and the Pacifi c // BIS. BIS Papers. growing infl uence in Asia-Pacifi c // BIS. USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Working Paper. 2014. No. 446. URL: http://www.bis.org/publ/work446.pdf 27. Tavlas G. S., Ozeki Y. Th e Inter- nationalization of Currencies: An Appraisal of the Japanese Yen // IMF. Occasional Paper. 1992. No. 90. 28. Tavlas G. S. Vehicle Currencies // Th e New Palgrave Dictionary of Money and Finance / P. Newman, M. Milgate, J. Eatwell (eds.). L.: Macmillan, 1992. P. 754–757. 29. Zhou X. Reform the international monetary system // People’s Bank of China. 2009. March 23. URL: http://www. pbc.gov.cn/english/130724/2842945/ index.html

22 THE RECENT EVOLUTION OF THE LOCAL CURRENCY PAYMENTS SYSTEM OF THE BRAZILIAN ECONOMY

Chapter 2

The Recent Evolution of the Local Currency Payments System of the Brazilian Economy1

Th e purpose of this chapter is to currency of the world economy. Although analyze the Brazilian Local Currency there is equal system between Brazil and Payments System with Argentina, Uruguay2, the available data are scarce, so regarding its economic and institutional the registers of the fi rst business are only aspects, and to evaluate the legal aspects of 2015, according to Brazilian Central of the Brazilian fi nancial system in order Bank. to consider possible steps for providing Th e Brazilian export variable was the basis for the integration of the BRICS chosen because it refl ects simultaneously local currencies. the preference of the Argentinean im- In the recent years the discussion porters and of the Brazilian exporters in concerning the international monetary invoicing their business in real inside the system and the convertibility of currencies SML. Both start to recognize advantages has been gathering pace, pointing that in transacting without the intermediation deepening of both production and of the US currency, and they gradually fi nancial globalization makes signifi cant begin to elect voluntarily the BRL as a diffi culties for developing countries currency of bilateral commerce. So, the in gaining long-term fi nancing and implementing the monetary policy. Brazilian currency stops carrying only its Because of inconvertibility their currencies classic functions internally and sketches do not carry out the basic functions of the some properties in the international plan. currency in the international monetary system. Is should be noticed that there is no international quotation of goods in Financial opening of inconvertible currencies, as well as they do Brazilian economy not serve as a currency of denomination for mercantile or fi nancial contracts and Biancareli (2010) analyses the main reserve assets. reforms in the Brazilian National Th is restraint has stimulated Brazilian Financial System, pointing to three levels policymakers to search mechanisms for of opening adopted by the Brazilian the construction of a Local Currency economy. Th e fi rst opening level began in Payments System between Brazil and the 1990s, under the Collor government Argentina, with fi nal cause to reduce and within the fi rst mandate of FHC, the dependence from the main reserve when the search started for a process 1 Uallace Moreira Lima — Federal University of liberalization of the means and of Bahia; Marcelo Xavier do Nascimento — Federal conditions of external debt through the University of Pernambuco. diversifi cation of instruments existed. 2 Th e agreement between the Central banks Within the second mandate of FHC, of Brazil and of Uruguay was signed in the end of there was a deepening of the liberalization 2014. Operations began only in 2015. We consider 23 it as a very short historical series, therefore we process in 1999 involving the alterations decided not to include it in this report. in the legislation regarding the treatment USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

to the foreign investors in the local Th e situation had been getting worse fi nancial market. from 1979 with two external shocks Th e second opening level was con- which aff ected not only the Brazilian nected with modifi cations in the legi- economy, but all countries that had slation referring to possession of extern depended from external capital fi nancing. assets, to the transfer of capital and to Th e fi rst shock was the elevation of the the internal debt of non-residents. Th is price for the oil barrel, which had raised level included the period from the end the prices from USD 12 to USD 30 per of the government of FHC till the fi rst barrel in the end of 1978 and beginning mandate of the Lula’s government. Th e of 1980. Th e second shock was the third opening level is associated with elevation of the international interest the convertibility of the local currency. rate, as a consequence of changes in the According to Biancareli (2010), measures US’ economic policy. for opening of the Brazilian economy Aft er the successive exchange crises were implemented abruptly, in so far as that reached Mexico (1995), Asia (1997) some macroeconomical variables started and Russia (1998), the Brazilian exchange to present higher level of instability and regime was changed in 1999, shift ing dependence regarding the internatio- from the regime of fi xed exchange to nal scenery. the regime of fl oating exchange, in For Freitas and Prates (2001), the order to maintain the increase in the measures for promoting the fi nancial currency value caused by the expressive opening in the 1990s took as main escape of capitals, besides the signifi cant objectives the relaxation of the foreign untenable imbalance of the swinging investors’ entering the national fi nancial of payments. Th is change of exchange market and the adaptation of the regulatory regime inaugurated a new phase of the landmark of fi nancing. According to the neoliberal economic model in Brazil, authors, the immediate result of these where the exports became a variable of measures was the liberalization of the extreme importance as a mechanism for portfólio foreign investments both in external agreement and remuneration the domestic and international capital of the fi nancial capital. Th is phase was markets, causing a favorable environment also marked by the adoption of two new for the predominance of the process orthodox measures in the economic of speculation to the detriment of the policy: infl ation targeting regime and productive investments. getting elevated primary surpluses. Both Th e process of fi nancial opening of the measures set that the control of infl ation Brazilian economy was associated with and is the main objective of the economic the turn of the international liquidity. policy in Brazil, to the detriment of Th us, the fi nancial liberalization, allied measures that provide a sustainable with elevated interest rates, has provided long-term economic growth. In fact, a substantial capital infl ow since 1991, the economic tripod — infl ation marks, which increased of the local reserves. fl oating exchange and fi scal surplus — Th e liquidity cycle in the world-wide can be understood through economic market entered the stage of decline aft er policy which guarantees the remuneration a crisis in the international market had of the fi nancial capital. begun in the 1970s. Th at was the result Th e evolution of the investment of the external sector crisis caused by oil fl ow in stock market and foreign direct price increase, and the crisis of fi nancing investment for Brazil confi rms the 24 in 1973 — that marked the end of a long hypothesis presented by Biancareli cycle of prosperity for the capitalism (2007), according to which during the managed by Bretton Woods’ System. rising phase of the cycle of international THE RECENT EVOLUTION OF THE LOCAL CURRENCY PAYMENTS SYSTEM OF THE BRAZILIAN ECONOMY liquidity investment in stock markets is stimulate the commerce for the reduction of the biggest importance for developing of the costs of transaction, to make easy countries. During the descending phase it the access of new small- and middle-sized is the foreign direct investment that leads economic agents, as well as to strengthen the movement of fall. Th e fact is that the the local currencies through the rea- indicators of the Brazilian economy point lization of regional business without the to the fact that the Brazilian option of intermediation of the dollar. being incorporated in the international Creating of this system inside market through the predominance of the Brazil started with the publication of fi nancial globalization process (capital prescriptive acts of the Central Bank, the account) turned to the creation of a much National Monetary Advice and of the more favorable economic environment Chamber of Exterior Commerce of the for speculative short-term investing and Presidency of the República4. However, the patrimonial direct investment, thus such acts were preceded by decisions of aggravating the country’s position in the Council of the Common Market of the international monetary system as MERCOSUR5, where the bases of the peripheral economy with an inconvertible SML were launched between Brazil and currency. Argentina. Th e strategy adopted by Brazil to Although the formation of the SML has reduce this vulnerability is to build a demanded the convergence of decisions mechanism of payment system using local of several persistence, the operation of the currencies in its commercial relations with system is carried out under an agreement other countries of the South America. It (BCB and BCBRA, 2008) signed is possible through the strengthening and between the Brazilian and Argentinean 3 deepening of the MERCOSUR . Central banks. Th e regulation sets that the payments in local currencies are The Local Currency allowed to any type of operation between residents in both countries. However, Payments System there is an authorization requirement, so that the Central bank at present restricts Th e Local Currency Payments System is the operations in common agreement a tool inserted along with the set of political contented by the monetary fl ows of measures of incitement to the integration import and export of goods and services. within the MERCOSUR countries. Th e Th e system does not work totally mechanism allows the economic agents without the US dollar, nevertheless it from diff erent countries to invoice the transmits to the economic agents enga- bilateral business in local currencies, thus ged the perception of which exchange reducing the costs of transaction asso- operation does not exist. It removes the ciated to the operation exchange and the embarrassment of the cost of transaction tax on fi nancial operations. of the purchase of the currency and According to the Central Bank of the eventual fl uctuations that can Brazil, the objectives of the system are: to compromise the income of the operation, 3 All countries of South America participate 4 in MERCOSUR, either as a Member State, or as Prescriptive circular of the Central Bank of an Associated State. 1) Member States: Argentina, Brazil No. 3.406/2008, Resolution of the National Brazil, Paraguay, Uruguay (from March 26, 1991) Monetary Advice No. 3.08/2008 and Resolution and Venezuela (from August 12, 2012). 2) States of the Chamber of Exterior Commerce 12/2007 in the process of incorporation: Bolivia (from respectively. December 7, 2012). Associated states: Chile (from 5 Decision of the Council of the Market 25 1996), Peru (from 2003), Colombia, Ecuador (from Common (MERCOSUR) No. 38/2006 and 2004), Guyana and Surinam (both from 2013). 25/2007. USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

besides dispensing the payment of the tax the conventional exchange in the per- on fi nancial operations in case of Brazil. ception of the importing agent. Two important characteristics of the Local Currency Payments System Evolution of the SML are distinctive: the voluntary character in data of joining the system and the position of an economic agent inside the Th e Table 1 presents a synthesis of commercial relationship between Brazil the Brazilian exports to Argentina during and Argentina. Being a volunteer to the last six years. Th e fi rst more general transact under the SML, the economic observation is that the total value of agent needs incentives to feel attracted. exports in dollars had been raising till To a large extent, the abolition of the 2011 and then decreasing, with reaching exchange operation removes barriers the same landing of the beginning of the and stimulates the entry of agents, earlier series. On the other side, the volume of repelled by high operational costs. In exports under the SML (in Brazilian general, operating inside the system currency) grew along the years, despite approaches to the internal commerce, being relatively stagnant from 2012. Still stimulates the competition and induces so, the exports invoiced in BRL increased the effi ciency of the economic agents. more than fi ve times, in a tendency Every external commercial rela- diff erent from the total exports invoiced tionship has the stage of commercial in USD. agreement, boarding and the liquidation It can seem fearful to compare the by means of the payment. Th e traditional same variable in completely diff erent mechanisms of commercial liberalization monetary unities, in special because the include both tariff and non-tariff barriers SML is a new instrument of voluntary (for stages of commercial agreement and use. Nevertheless, aft er conversion to US board). It does not predict changes in the dollars by the annual average exchange rate, it is extracted a near value in BRL rate of a currency that will be used for the that makes possible the comparison turnover and liquidation (in general — between the two forms of exportation. the USD). With the values adjusted to the same Th e Local Currency Payments System monetary unity it is seen that despite operates exactly at the stage of the of the accented devaluation of the real, turnover and liquidation, substituting that reduces the quotient in dollars, the turnover in foreign currency for the the share of the exports under SML has local currencies of the wrapped countries. reached little more than 6%. In fact, this Incentives for the economic agents, as may look negligible, but, if compared mentioned above, are the abolition of with the quantity of operations of export the exchange cost and the possibility to contracted from 2009, it becomes clear eff ectuate the operational calculation in that there was a signifi cant growth of the a familiar currency, knowing in advance voluntary use of the SML. In accordance the value of the bill that will be received. with the Central Bank of Brazil, the By the side of the importer, according growth was tenfold, reaching the mark to the rules of the system, the paid value of almost eleven thousand operations will not be known in advance, since it in 2015. depends on the Tax SML for the day of Aft er six years of eff ective functioning making the operation. Nevertheless, these the SML between Brazil and Argentina 26 exchange rates use the local currencies results achieved make clear that there without the straight intermediation of is a growing interest of the economic THE RECENT EVOLUTION OF THE LOCAL CURRENCY PAYMENTS SYSTEM OF THE BRAZILIAN ECONOMY

Table 1 Exports to Argentina Year Value exported, Value exported Exchange Value exported B/A, USD (A) under SML, BRL rate, under SML, USD % BRL/USD (B) 2009 12,784,699,502 451,061,104.78 1.74 259,170,940.46 2.0 2010 18,522,520,610 1,252,700,533.25 1.67 752,191,997.87 4.1 2011 22,709,344,431 1,623,201,038.91 1.88 865,661,052.16 3.8 2012 17,997,706,375 2,277,897,217.86 2.04 1,115,031,189.91 6.2 2013 19,615,414,342 2,581,447,704.82 2.34 1,102,240,693.77 5.6 2014 14,281,998,035 2,313,261,335.97 2.66 871,088,016.26 6.1 2015 12,800,015,447 2,504,490,534.16 3.90 641,486,228.72 5.0 Source: Ministry of Development, Industry and Foreign Trade; Central Bank of Brazil Note: Th e exchange rate used is an annual medium calculated by Central Bank of Brazil agents wrapped in carrying out extern thing goes for the share in total imports transactions without the intermediation by Brazil, which does not reach 1%. of the dollar. How the turnover is made Th e discrepancy between the dynamic with national currencies under the SML, bilateral of commerce between Brazil and it is worth observing with attention to the Argentina under the SML refl ects, fi rst evolution of value in BRL, because these of all, the preferences of the economic agents, that can be caused by a set of value, being converted in dollar, serves reasons concerning the each country’s only to estimate the SML share in the internal order. Th e lack of interest of total exports. the Argentinean exporters in invoicing Th e opposite takes place when we in their local currency and keeping on observe the Brazilian imports with origin negotiating in the US currency, though in Argentina. Th ough there had been it is not the object of the current analysis, more than nine-time growth during six can be a sign of low internationalization of presented years, the biggest imported the Peso. Besides, such an asymmetry can value hasn’t reached BRL 40 million and mean that the SML works well only for one USD 9 million when converted. Th e same of the countries. Th at might be reduced

Table 2 Imports from Argentina Year Value imported, Value imported Exchange Value imported B/A, USD (A) under SML, BRL rate, under SML, USD % BRL/USD (B) 2009 10,955,256,800 4,296,941.53 1.74 2,468,939.05 0.023 2010 14,434,593,883 8,998,129.07 1.67 5,402,983.71 0.037 2011 16,906,351,476 8,736,895.69 1.88 4,659,429.20 0.028 2012 16,444,158,185 17,245,299.73 2.04 8,441,578.02 0.051 2013 16,462,685,523 10,525,643.55 2.34 4,494,296.99 0.027 2014 14,142,927,904 5,033,622.97 2.66 1,895,474.83 0.013 2015 10,284,589,084 37,573,226.81 3.90 9,623,796.63 0.094 Source: Ministry of Development, Industry and Foreign Trade; Central Bank of Brazil 27 Note: Th e exchange rate used is an annual medium calculated by Central Bank of Brazil USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Table 3 Twenty principal goods exported to Argentina in 2015 Value in USD NCM Goods (FOB) Vehicles; with only spark-ignition internal combustion 87032310 1,699,472,906 recipocating piston engine, cylinder capacity Vehicles; with only spark-ignition internal combustion 87032210 705,061,215 recipocating piston engine, cylinder capacity Vehicles; compression-ignition internal combustion piston 87042210 305,948,970 engine (diesel or semi-diesel), for transport 87012000 Tractors; road, for semi-trailers 285,784,532 Iron ores and concentrates; agglomerated (excluding 26011210 214,469,174 roasted iron pyrites) Vehicles; parts and accessories, of bodies, other then safety 87082999 211,825,702 seat belts Vehicles; spark-ignition internal combustion piston 87043190 205,826,452 engine, for transport of goods (of a g.v.w. not exceeding 5t) Engines; reciprocating piston engine, of a kind used for the 84073490 propulsion of vehicles of chapter 87, of a cylinder capacity 198,081,154 exceeding 1000cc Vehicle parts; drive-axles with diff eretial, whether or not 87085080 provided with other transmission components, and non- 192,830,872 driving axles; parts thereof Vehicles; compression-ignition internal combustion piston 87042190 181,504,093 engine(diesel or semi-diesel), for transport 87089990 Vehicle parts and accessories; n.e.c. in heading No. 8708 161,167,572 Chassis; fi tted with engines, for the motor vehicles of 87060010 153,672,563 heading No. 8701 to 8705 26011100 Iron ores and concentrates; non-agglomerated 134,797,017 Rubber; new pneumatic tyres, of a kind used on buses or 40112090 133,579,090 lorries 28182010 Aluminium oxide; other than artifi cial corundum 130,045,787 87083090 Vehicle parts; brakes, servo-brakes and parts thereof 114,317,652 Vehicles; with only spark-ignition internal combustion 87032100 111,053,346 recipocating piston engine,cylinder capacity Ethylene polymers; in primary forms, polyethylene having 39012029 102,612,249 a specifi c gravity of 0.94 or more 87084080 Vehicle parts; gear boxes and parts thereof 93,167,775 Vehicle parts; suspension systems and parts thereof 87088000 91,229,752 (including shock-absorbers) Total 5,426,448,173 Total exports to Argentina 12,800,015,447

28 Source: Ministry of Development, Industry and Foreign Trade; Central Bank of Brazil THE RECENT EVOLUTION OF THE LOCAL CURRENCY PAYMENTS SYSTEM OF THE BRAZILIAN ECONOMY by more eff ective policy providing diff e- indicate that there is a positive answer rent incentives for using the system. to advantages from invoicing business in In the Table 3 and Table 4 twenty main BRL, and that there are exporting sectors goods exported to Argentina in 2015 are in Brazil interested in transacting without listed, both in USD (Table 3) and under the mediation of the dollar exchange. the SML (Table 4). Th e separation of the activities follows the CNAE standards The national with regard to the SML and NCM to financial system the exports in dollar. Although the after 2003 classifi cations diff er from the qualitative observation of the subsectors, it is possible to identify the exporting activities that Th e changes of the 1980s in the national follow certain standards. fi nancial system and in the Brazilian Th e group of activities presented in economy deepened the participation of the Table 3 corresponds to 42% of the foreign capitals in the home market, along 6 Brazilian exports to Argentina. It shows with changes in the Federal Constitution . that the most dynamic group of exports is Aft er the beginning of Real Plan in 1994 the automotive industry (code 87), which the currency board was adopted, aiming holds more than 30% of the total volume at fi ghting against infl ation and creating presented in the Table, being followed to conditions for the captivation of external the distance by the mining and chemical fi nancing. Th e fi xed exchange rate put the products (Codes 26 and 28). new national currency in equality with the Th e list of Brazilian exports under US dollar. Th is added to the commercial SML presented in the Table 4 still shows a opening and intensifi ed the trabe balance 7 predominance of the automotive industry defi cit . Th e Fernando Henrique Cardoso (code 29), where only nine goods holds government tried to counterbalance this 28% of all the exports invoiced in BRL imbalance through a passive monetary and more than 50% of the used sample. politics executed to adjust the Swinging On the other side there is a reasonable of Payments on the Capital account. Th e diversifi cation in many products like the elevated interest rates of the public titles sector of metallurgy (code 24), which linked to the dollar attracted signifi cant production is most exported under volumes of capitals for short-term the SML. investment. Eleven remaining sectors of the Lack of control over the infl ation in selected list add up nearly 40% of the local the 1980s and beginning of the 1990s sales in Argentina with foodstuff s, paved, made diffi cult for the national currency material to offi ce, glass and wholesale to carry out its basic functions, and when commerce. Th ese data contrasts with the the context of restriction of the balance Table 3, in which the goods connected of payments was given it was a need for with the motor sector occupy almost the external emblems to balance the internal whole list (in dollars). environment. Within this period there Th e existence of the SML reveals a was no discussion, more or less initiative, subtle alteration in the list of twenty 6 Th e Correction to the Constitution number main products exported from Brazil to 40/2003 moved several legal restrictions of the Argentina. Th e predominance of the national fi nancial system. automotive industry sector and associated 7 Between 1995 and 1999 the balance of that sectors is incontestable, although its of the Commercial Swinging was negative, a period weight inside the SML is relatively less. in which the government supported an exchange politics of equality with the US dollar. Th e surplus 29 Th e appearance of other sectors with began in the next year strongly infl uenced by the greater distinction in the SML can devaluation of the real in 1999. USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Table 4 Twenty principal goods exported to Argentina in 2015 under the SML

CNAE Goods Value in BRL Value in USD code Production of carbon steel fl at rolled 2422901 179,213,201.68 45,952,102.99 products Vanufacture of other parts and 2949299 accessories for motor vehicles no 138,388,603.22 35,388,603.22 elsewhere classifi ed 2910701 Manufacture of cart, vans and buses 117,871,466.96 30,223,453.07 Manufacture of parts and accessories for 2942500 the systems of running and transmission 96,189,530.76 24,663,982.25 of motor vehicles Production of fl at-rolled carbon steel, 2422901 79,025,765.52 20,263,016.80 whether or not coated Manufacture of benches and upholstery 2949201 69,147,111.98 17,730,028.71 for motor vehicles Manufacture of cometics, perfumery 2063100 68,182,002.51 17,482,564.75 and toilet preparationa 2211100 Manufacture of tires and inner tubes 65,677,109.85 16,840,284.58 Combined offi ce and administrative 8211300 59,381,983.54 15,226,149.63 support services Manufacture of other parts and 2949299 accessories for motor vehicles not 51,915,966.20 13,311,786.21 elsewhere classifi ed Manufacture of parts and accessories for 2942500 the systems of running and transmission 48,173,893.14 12,352,280.29 of motor vehicles Manufacture of fl at glass and security 2311700 43,534,154.12 11,162,603.62 glass Manufacture of synthetic leather 1533500 footwear 38,673,607.36 9,916,309.58 Manufacture of other parts and accessories for motor vehicles not 2949299 elsewhere classifi ed 31,427,863.35 8,058,426.50 1531901 Manufacture of leather footwear 31,081,668.37 7,969,658.56 Manufacture of fl at glass and security 2311700 glass 30,566,479.01 7,837,558.72 1531901 Manufacture of leather footwear 29,874,766.70 7,660,196.59 4530702 Manufacture of tires and inner tubes 29,147,946.69 7,473832.48 Manufacture of preserved fi sh, 1020102 crustaceans and molluscs 27,636,372.18 7,086,249.28 Manufacture of parts and accessories for 2941700 motor vehicles 26,625,892.91 6,827,152.03 Total 1,261,362,335.37 323,426,239.84 Total exported to Argentina under the SML 2,329,925,757.49 597,416,860.89

30 Source: Central Bank of Brazil Note: Th e exchange rate used is an annual medium calculated by Central Bank of Brazil THE RECENT EVOLUTION OF THE LOCAL CURRENCY PAYMENTS SYSTEM OF THE BRAZILIAN ECONOMY concerning using Brazilian currency not signifi cant in the total amount of in the turnover of the international the Brazilian reserves held in foreign commerce, mainly because the Brazilian currencies. Th e USD still represents economy had suff ered in the previous 83% of the reserves10. Th at suggests decade with elevated infl ation rates and that only a small part of business is in successive plans of monetary stabilization currencies of the developing countries. that did not work. Nevertheless, the Resolution 3844/2010 Th e external imbalance produced by allows fi nancial transfers for the outside the economic management of the FHC in any currency, in other words, there is government became an impetus to force a legal authorization for the remittance the adoption of measures for attraction of currencies without distinction11. Such and maintenance of foreign emblems a prescriptive act can open space for through high interest and restriction circulation of the currencies of the BRICS of the internal demand. Only in 2007, among the countries. In case of real, its use under the Squid government, it was for promises liquidation abroad is allowed allowed to receive the export revenues in by the Circular 3691/2103 (articles 6 and reals8. Th e use of the Brazilian currency 8). So, the Brazilian legislation allows so was stimulated also by the Resolution much the possession of bank accounts 3844/2010 that allowed fi nancial transfers for foreign offi cial institutions and for the outside in any currency, and by enterprises, both for exchange operations, the circular 3691/2103 that allowed the and interbank transfers in any currency. liquidation of promises abroad with Th e activity of foreign fi nancial national currency. institutions in the Brazilian market Th e participation of enterprises and depends on authorization from the foreign institutions in the Brazilian market Central Bank of Brazil and from was enlarged with the permission to have the Federal Executive Power (law accounts in reals under Circular Letter 4.595/1964). Non-fi nancial enterprises in No. 3691/2013 of the Brazilian Central Brazil need to ask for authorization the Bank, but only for foreign exchange Ministry of Industry Development and 9 operations . In the same sense, the law Exterior Commerce to establish branches 11.803/2008 authorised the Central Bank or agencies, if they want to operate of Brazil to maintain counts of deposit in in the country. Meantime, there is an reals of property of foreign Central Banks, instrument called Brazilian Depositary foreign institutions and enterprises that Receipt that allows the foreign enterprises work with compensation, liquidation to operate in the Brazilian market with and custody in the international market. local currency (BM&F Bovespa, 2011). In case of the foreign Central banks, the Th e issuance of marketable securities Resolution 4.202/2013 determined that is authorized only to companies that the counts in Brazilian currency could be constitute the capital in national currency opened and maintained exclusively in the (article 5 of Law 6.404/1976) and submit name of foreign Central Banks with which to the regulation of the National Mone- the Central Bank of Brazil had celebrated tary Council and the Brazilian Securities contracts of swap of local currency. and Exchange Commission. Th us, there For the aims of this report, weight of the BRICS countries’ currencies is 10 In December 2015, the structure of reserves was as follows: US dollar — 83%, 8 Resolution No. 12/2007 of Chamber of euro — 4.6%, Canadian dollar — 4.3% in euro, exterior commerce of the Ministry of Industry pound sterling — 3%, Australian dollar — 2.7%, Development and exterior Commerce. yen — 1.8% and gold — 0.7%. 31 9 We did not obtain an answer from the 11 Currencies of China and of South Africa Central Bank of Brazil on the data availiable. are traded at the Stock Exchange of São Paulo. USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

is a restriction for foreign fi nancial export and import. It is clear that there is companies and institutions wishing to a mismatch in the use of the system for operate in the Brazilian securities market. the economic agents of two countries. In the case of Brazilian companies, they Perhaps it is only a refl ection of the size of may trade in the United States through the internal economies, which is refl ected American Depositary Receipts, which to be the total exported. Meantime, as soon are securities issued by the US Securities as the stimuli policies are equivalent, aft er and Exchange Commission of the six years of operation the low turnover United States. According to consultancy value in Peso also can expose a situation Economática, which tracks the actions in which the local currency is not much of 28 Brazilian companies traded at the accepted for international operations, even Stock Exchange of New York, in 2016 inside a robust institutional outline as it is the value of transactions was equal to the the MERCOSUR. half of the turnover volume of the Stock Th e appearance of eleven diff erent Exchange of Sao Paulo, and 10 Brazilian sectors in the exports under the SML enterprises have business volume above indicates that the incentives in Brazil were the average of the actions of the US eff ective in the direction of encouraging enterprises (Economática, 2016). new economic agents. Th e change in the Th e Brazilian multinationals in condi- group of goods exported under the SML tions of giving out marketable papers (Table 4) also is an indicator of changes in abroad can be analyzed by their degree of the perception on the Brazilian currency, internationalization12. In accordance with which assumes to some extent the function a study of the Dom Cabral Foundation of unity of account for the regional (2016), which measures and monitors commerce. the internationalization of the Brazilian Th e experience of the Local Currency multinational enterprises, from a sample Payment System as a public policy is of 63 enterprises, 49 they act out of Brazil restricted by abolishing the transaction with own unities (the remainder — cost of the exchange operation and the through franchises). Within the used wrapped taxation. Th ere is no special sample, nearly 10 multinationals obtain treatment for the stage of shipment or more than 50% of receipts beyond Brazil. customs, which continues similar to Another important fact is a geographical exporting in US dollars. Th e mapping of distribution of the branches: they are this stage and the identifi cation of some presented in almost all continents and, item susceptible to the abolition would for the aims of this study, there are bring probably an additional stimulus to branches of Brazilian multinationals in the adhesion to the system. all BRICS countries. Th e discrepancy between exports and imports inside the SML produces Final considerations an imbalance of the SML’s balance of payments. In the case open to question, Th e brief exhibition of the data there is a great imbalance in favor of concerning SML agreement between Brazil in every year of the series. Th at Brazil and Argentina shows that the depends on the incentives for economic system works by means of encouraging agents; that may require specifi c policies in the fi nancial sphere of the operation of of encouraging. Opposite case, with the system only bringing benefi ts to a side 12 Th e Foundation Dom Cabral uses the the interest of the country in unfavorable rate of internationalization of the UNCTAD. It is situation of the agreement can be short. 32 calculated according to the next form: (total assets outside / total income + number of employees From the data shown in the Table 4, it outside / total of employees)/3. is worth to plan a policy plan to stimulate THE RECENT EVOLUTION OF THE LOCAL CURRENCY PAYMENTS SYSTEM OF THE BRAZILIAN ECONOMY those sectors that use the SML like road and then — by dollar as the main of alternative export, by undertaking the reference currency. Herewith, there were more accurate analysis of the profi le of always doubts on the question which such economic agents and the reasons that one could be the main reference point, led them to opting for the SML, besides accompanied with eff orts to create an those already known ones. Also for those appropriate payment system. more powerful sectors within the SML, To give support to the BRICS claims just like the motor one, it is worth thinking for comparing the infl uence of the US about policies to drive more still the use of currency without repeating the mis- the system. takes of this system, it is necessary: to Th e experience of a Local Currency reduce the volatility of the exchange Payments System already existent and rates between the currencies wrapped reasonably consolidated was related brie- in order to avoid speculative positions fl y. Th e mechanisms for construction and and establish a collective action of the management respond to the peculiarities Central banks for avoiding exchange of the MERCOSUR, however they can war between the countries. Th e choice become a model of stimulus to the of just one currency is not in the core regionalism. Besides, it induces the of the political objectives of the BRICS, reduction of the dependence regarding so the main idea is: to stimulate the use the dollar, which is in the root of the of the local currency circulating freely, imbalances of the swinging of payments building an exchange rate that refl ects of the most of the developing countries. the combination to historical average of At the time the dollar remains the commercial transactions between the main currency of international the countries, the GDP, the degree of in- negotiation, and a reference unity for ternationalization of the currency and intermediating the exchange with non- the productivity of the factors. Initially, convertible currencies. Th ere are attempts the dollar would be still a parameter of of reducing this dependence through comparison, subsequently substituted mechanisms that put the non-convertible local currencies in face one of other one. by the local currencies themselves. Th e A good example is the SML between Bra- strongest savings and the most present zil and Argentina, which works well and currencies in other markets would have volume of business grows. However, this his most valued currencies and vice-versa. one does not do without the US dollar as Th e internationalization of the BRICS- a calculated parameter. Th e exchange rate currencies depends on the liquidity and of the SML is obtained from the relation on the degree of opening of BRICS` of the respective currencies of Brazil fi nancial markets: depth, elasticity and Argentina with the US dollar. So, and elevated volume of the wholesale that does not protect the tax SML from markets, confi dence in the fi nancial eventual abrupt exchange oscillations. power of the markets and standards On the contrary, it will be going to refl ect regulatórios aligned. Th ese agreements them in the local currencies, and the suff ered more deep alterations (BCB’s economic agents do not realize the eff ect Resolution 3844/2010 (it allows fi nancial pass-through for the tax SML. transfers for the outside in any currency Th e construction of an alternative and Circular Letter 3691/2103 that al- system of payments, in a fi rst observation, lows the liquidation of promises abroad passes by the substitution for another with national currency) in the internal currency or commodity. Th us, in the and political stimulus legislation to the XXth century the gold standard was use of the local currency (in case of Brazil) 33 initially replaced by a dollar-gold one, in other markets, besides the reciprocity USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

of these last ones to accept business References in real. Th e experience of the SML between 1. ADR's brasileiros movimentam US$ Brazil and Argentina demonstrates 1 bilhão em média por dia nos USA — that there is already some degree of As ADR's equivalem a mais de 50% da internationalization of the real and Bovespa — 10 ADR's têm movimento adhesion of Brazilian enterprises in maior nos USA em comparação com o invoicing in the Brazilian currency, since Mercado local // ECONOMÁTICA. 2016. there is a policy set that stimulates the October 4. URL: http://economatica. participation the system. Th e Brazilian com/estudos/data/20161004a.pdf multinationals operating abroad, under more several forms, also are an evidence 2. Biancareli A. A abertura fi nanceira of the internationalization of the pro- no Brasil: um balanço crítico // Sistema duction and penetration in the foreign fi nanceiro e desenvolvimento no Brasil: fi nancial markets (in the case of the Stock do Plano Real à crise fi nanceira / Org. Exchange of New York). It is risked to L. C. Marcolino, R. Carneiro. São Paulo: answer these enterprises they would be Publisher Brasil e Editora Gráfi ca Atitude, disposed in substituting the BRL at the 2010. P. 55–88. receiving of his bills, at last they operate in 3. Biancareli A. Integração, ciclos e fi - several markets with diff erent currencies. nanças domésticas: o Brasil na globali- Meantime, it is reasonable to believe that zação fi nanceira: Tese de Doutoramento. when a stimulus is in the form of public IE/Unicamp, 2007. politics, mainly what withdraws the 4. Brazilian Depositary Receipts unpredictability of the exchange relation (BDRs) // BM&F Bovespa. 2011. URL: in the current system, the adhesion will http://www.bmfbovespa.com.br/pt-br/ take place in the similar form to the SML servicos/download/BDR_Patrocinados_ Brazil-Argentina. Portugues.pdf Th e foreign enterprises that act in 5. Carneiro R. Globalização e inconver- Brazil, under the local laws, have been sibilidade monetária // IE/Unicamp. demonstrating interest in invoicing in Texto para Discussão. 2006. No. 120. URL: BRL, just like the motor enterprises (all http://www.eco.unicamp.br/docprod/ foreigners multinationals) which use downarq.php?id=1750&tp=a transacting under SML. Nevertheless, while joining the Brazilian market such 6. Carvalho C. E., Vidotto C. A. Aber- enterprises become national in accordance tura do Setor Bancário ao Capital with the legislation in force and since the Estrangeiro nos Anos 1990: os objetivos treatment was already reported to the e o discurso do governo e dos banqueiros foreign enterprises with thirst abroad the // Nova Economia. 2007. Vol. 17. No. 3. same thing is not, though it could dispose P. 395–425. URL: http://www.scielo. of counts near the Central Bank of Brazil br/scielo.php?script=sci_arttext&pid in BRL for exchange operations and remit =S0103-63512007000300002 any currency for the outside. 7. Convênio do Sistema de Pagamentos em Moeda Local entre a República Argentina e a República Federativa do Brasil // Banco Central Do Brasil. 2008. September 8. URL: http://www.bcb.gov. br/rex/sml/convenio-sml-pt.pdf 34 8. Eichengreen B., Hausmann R., Panizza U. Currency mismatches, debt intolerance and original sin: why they THE RECENT EVOLUTION OF THE LOCAL CURRENCY PAYMENTS SYSTEM OF THE BRAZILIAN ECONOMY are not the same and why it matters // National Bureau of Economic Research. Working Paper. 2003. No. 10036. URL: http://www.nber.org/papers/w10036.pdf 9. Eichengreen B., Hausmann R., Panizza U. Original sin: Th e Pain, the Mystery and the Road to Redemption. Conference “Currency and Maturity Matchmaking: Redeeming Debt from Original Sin”. Washington, D.C. 2002. November 21–22. URL: http:// www.financialpolicy.org/financedev/ hausmann2002.pdf 10. Filgueiras L. História do Plano Real. São Paulo: Boitempo, 2000. 11. Freitas M.C.P., Prates D.M. A aber- tura fi nanceira no governo FHC: impactos e conseqüências // Economia e Sociedade. 2001. Vol. 17. P. 81–111. 12. Ranking de Multinacionais brasi- leiras 2015 // Fundação Dom Cabral. 2016. URL: http://www.fdc.org.br/ blogespacodialogo/Documents/2015/ ranking_fdc_multinacionais_ brasileiras2015.pdf 13. SML — Sistema de Pagamentos em Moeda Local // Banco Central Do Brasil. 2016. URL: http://www.bcb.gov. br/pt-br/#!/n/sml

35 USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Chapter 3

Russia’s Deal on Promoting the Regional Status of the Ruble1

In the 1990s-2000s Russian ruble exchange regulation and transition to a has evolved from almost inconvertible full convertibility of the ruble including unit into a currency with no restrictions capital transactions. Th is aim was set in on both current and capital account President Vladimir Putin’s Address to the convertibility in terms of national Federal Assembly in May 20032. legislation. Th is process (along with the New revision of the Federal Law on results achieved) is represented here with Foreign Exchange Regulation and Control regard to changes in foreign exchange passed in December 2003 (dated Decem- regulation, using the ruble in foreign ber 10, 2003, No. 173-FZ) proclaimed free trade, and developing both the FX and exercise of foreign exchange transactions fi nancial markets. between residents and non-residents. Restrictive administrative measures Foreign exchange could only be imposed on certain regulation transactions associated with capital fl ows and only in cases stipulated explicitly In Russia partial current account by the law. Almost all restrictions convertibility of the ruble was guaranteed were supposed to be removed from as early as in the mid of 1990s. Even the January 1, 2007. However, this process fi rst edition of the act on Foreign Exchange was subsequently modifi ed. Regulation and Foreign Exchange Con- In the Address to the Federal trol dated October 9, 1992 stipulated Assembly on May 10, 2006 President the removal of restrictions on using the Vladimir Putin noted the progress Russian currency for current payments made by the Government in promoting and transfers for residents. In June 1996 a full convertibility of the ruble and aft er Russia accessed to Article VIII of the recommended to accelerate this process IMF’s Articles of Agreement this regime with removing all remaining restrictions was extended to non-residents as well. from July 1, 20063. Since the mid-2006, At the height of the 1998 crisis, the the requirement of the Bank of Russia Russian government strengthened foreign obliging to reserve funds while performing exchange control. However, as fi nancial foreign exchange capital transactions stability grew most of the restrictions was abolished. Moreover, the Federal introduced in 1998–99 were either eased Law on Foreign Exchange Regulation or cancelled. and Control (No. 131-FZ dated July Resumption of economic growth and substantial improvement of the 2 Annual Address to the Federal Assembly payments balance in the early 2000s gave of the Russian Federation // President of Russia: rise to further liberalization of foreign offi cial website. 2003. May 16. URL: http:// en.kremlin. ru/events/president/transcripts/21998 3 Annual Address to the Federal Assembly 36 1 Sergey Karataev, Nikolay Troshin, Nataliya of the Russian Federation // President of Russia: Gribova, Pavel Zakharov, Ivan Bazhenov — offi cial website. 2006. May 10. URL: http:// Russian Institute for Strategic Studies. en.kremlin. ru/events/president/transcripts/23577 RUSSIA’S DEAL ON PROMOTING THE REGIONAL STATUS OF THE RUBLE

Exports Imports 1, 600, 000

1, 400, 000

1, 200, 000

1, 000, 000

800, 000

600, 000

400, 000

200, 000

0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Figure 1. Volumes of cross-border ruble payments with Belarus, Kazakhstan, Kyrgyzstan and Tajikistan, bn rubles Source: Interstate Bank; authors’ calculations

26, 2006) was amended to remove the a transaction certifi cate remains intact in power previously granted to the Rus- case of the transaction occurred between sian Government and the Bank of Russia, Russian resident and non-resident4. to restrict foreign exchange transactions. Th ese requirements are not only Since that moment, the ruble can be burdensome for business but also work offi cially regarded as fully convertible. discouraging on using the Russian Non-residents were entitled to carry currency in international transactions. out any transactions with the Russian Moreover, such requirements run con- currency without limitations: open trary to the goal of internalization of the accounts, perform cross-border trans- ruble by inducing ruble infl ows back into fers, purchase securities etc. Russia. Still the Russian legislation (parti- cularly, bylaws) contains a number of provisions, mostly in the fi eld of foreign exchange control, signifi cantly hindering 4 Currently, a transaction certifi cate (deal the ruble global turnover. Th us, the passport) is needed only if the amount of obligations under the agreement is equal to or rule of export proceeds’ compulsory exceeds the equivalent of USD 50, 000. In May 2017 repatriation is still in force (i.e. crediting the Ministry of fi nance representatives announced these proceeds to an authorized bank’s the cancellation of trans-action certifi cates that account within the territory of the Russian could be probably put into force in several months. See Minfi n: pasporta sdelok s nerezidentami 37 Federation), which also applies to ruble otmenyat // Vesti Ekonomika. 2017. May 11. URL: revenues. Th e requirement for making http://www. vestifi nance.ru/articles/85249 USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Exports (whole world) Exports (non-CIS states) Imports (whole world) Imports (non-CIS states) 1, 600

1, 400

1, 200

1, 000

800

600

400

200

0 Q12013 Q32013 Q12014 Q32014 Q12015 Q32015 Q12016 Q32016 Figure 2. Volumes of cross-border payments in rubles with the whole world and non-CIS countries, bn rubles Source: Bank of Russia; authors’ calculations Using the ruble billion rubles to 445.2 billion rubles, or by in foreign trade 80% (Figure 1). Th e volume of ruble payments for in goods and services the goods imported to Russia from these countries also increased, but in a lesser Liberalization of foreign exchange degree. Demand of the CIS states for regulation and removal of restrictions on freely convertible currency to form their capital fl ow led to growth of cross-border international reserves determined their transactions in rubles. Primarily, the opting for the US dollar as a means of Russian currency began to regain position payment for their goods. Nevertheless, in the post-Soviet countries. National the volumes of ruble capital transfers, companies started to accept payments in received by companies of the four- rubles for their supplies to the CIS states abovementioned countries grew from more willingly. For example, according to 204.3 billion rubles in 2005 to 292.2 bil- the Interstate Bank’s data collected from lion rubles in 2008 or by 43%. the central banks of Belarus, Kazakhstan, In 2009 the world economy crisis froze Kyrgyzstan and Tajikistan, the volume of ruble transactions growth, but it resumed 38 ruble payments for Russian goods in the subsequently. In 2015, the volume of period from 2005 to 2008 grew from 247.5 ruble payments for the Russian exports RUSSIA’S DEAL ON PROMOTING THE REGIONAL STATUS OF THE RUBLE

RUB share in the exports receipts USD share in the exports receipts EUR share in the exports receipts 90

80

70

60

50

40

30

20

10

0 Q32013 Q42013 Q12013 Q22013 Q12014 Q22014 Q32014 Q42014 Q12015 Q22015 Q32015 Q42015 Q12016 Q22016 Q32016

Figure 3. Currency structure of the Russian exports receipts, % Source: Bank of Russia; authors’ calculations reached 1,417.8 billion rubles, while the balance of payments concerning payments for imports reached 909.5 absolute values of trade volume, this billion rubles. Th e Bank of Russia data aff ords to assess (with more or less generally confi rms these dynamics, accuracy) the ruble payments volume not though the data on capital transfers for only in the trade with the CIS countries, the goods imported by Russia still diverge but also with the whole world. in some cases. In particular, it concerns Th e share of ruble receipts for the the crisis year of 2009, when the volume of exports from Russia amounted to 1.9 ruble transfers increased, while national trillion rubles in 2013, 37.4% of which central banks documented its decrease, represented Belarus, Kazakhstan, Kyrgyz- according to the Russian regulator. stan and Tajikistan, while payments Th e Bank of Russia has recently started for imports amounted to 4.2 trillion to disclose data on currency structure of rubles (the share of Belarus, Kazakhstan, foreign trade in goods and services. Th e Kyrgyzstan and Tajikistan was 14.3%). Figure 2 highlights quarterly data on the Th erefore, unlike settlements with the ruble, US dollar and euro share in exports CIS countries, settlements with non- receipts and imports payments, starting CIS states show preponderance of ruble from Q1 20135. Together with data from payments for the imports over ruble receipts for the exports, resulting in the 5 See Currency Composition of Settlements 39 for Goods and Services // Bank of Russia. URL: development of external ruble market. http:// www.cbr.ru/statistics/?PrtId=svs In 2015, ruble receipts for the Russian USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

exports increased almost to 3 trillion exports. In particular, in 2013 the share rubles, while payments for imports of oil and other energy and fuel recourses increased to 4.8 trillion rubles. Along amounted to over 70% of the total value with it, the share of the abovementioned of the Russian exports. Together with four countries grew insignifi cantly to ferrous and nonferrous metals, as well as 40.9% and 15.4% respectively. Th is was gold the share of raw materials increases basically caused by stagnation (and even up to 82%. Prices for most of these goods cut-down) of ruble settlements with other are set mainly in the US dollars. As a result, CIS states — mainly with Ukraine. the share of the US dollar in the receipts However, the deterioration of political for the Russian exports in the same year situation did not actually aff ect the of 2013 amounted to 79.6%. Relatively volume of ruble settlements with non- large share of the ruble in the settlements CIS states (Figure 2). Despite the anti- with the CIS states as compared to Russian economic sanctions imposed non-CIS states can be also attributed to by the United States and their allies, the reliance of the foreign exchange structure volume of ruble settlements with non-CIS of the exports receipts on its commodity states continued its growth almost at such structure. In 2013 export of energy and rate as it was with Belarus, Kazakhstan, fuel recourses to non-CIS states amounted Kyrgyzstan and Tajikistan. Only for the to 74.5%, raw materials in whole — fi rst 9 months of 2016, the volume of 85.7% from the total value of the exports7. receipts for the Russian exports to non- 84.2% of the exports were settled in the CIS states amounted to 1.24 trillion rubles, US dollars, while rubles amounted only and payments for the imports — 2.91 to 5.5%. However, in the trade with the trillion rubles, thus showing a growth of CIS states the share of oil as well as other 27.6% and 9.8% respectively as compared raw materials in whole was signifi cantly to the same period in 2015. less (47% and 59.5% respectively)8. As a At the same time, absolute values do not result, the US dollar accounts for only provide a broad picture of using the ruble 44.4% of the total value of receipts for in international settlements. For more the exports to the CIS states. Th e share precise assessment of its place and role of the ruble in the exports settlements is in the total fl ow of cross-border receipts amounting to 47%. and payments of Russian companies, we Th us, there is a clear direct correlation should address the Russian foreign trade between the share of raw materials currency structure. (primarily, oil) in the Russian exports According to offi cial statistics, the and the share of the US dollar in the ruble share in receipts for the exports receipts. It does not however mean that of goods and services from Russia is the share of the ruble in the receipts for relatively low, amounting to 10—15% of the exports would grow automatically the total receipts volume6. Th e main body with the decrease of the share of energy of foreign exchange earnings is formed and fuel recourses in the Russian exports by the US dollar. Th e share of euro in structure. Th is notably appears from its receipts for the exports is comparable to movements in recent times. While the raw the share of the ruble, though Euro-area materials share in the Russian exports in countries account for 40% of the Russian the fi rst three quarters of 2013 decreased exports at least (Figure 3). by 10.5 pp (oil and gas — even 14.5%). Such receipts structure is attributed to resource-based nature of the Russian 7 See Exports commodity structure for January 2013 — December 2013 // Federal customs 40 6 See Currency Composition of Settlements service. URL: http://stat.customs.ru/apex/ f?p=20 for Goods and Services // Bank of Russia. URL: 1:7:2854010855712102::NO http:// www.cbr.ru/statistics/?PrtId=svs 8 Ibid. RUSSIA’S DEAL ON PROMOTING THE REGIONAL STATUS OF THE RUBLE

Share of the ruble in the exports receipts Share of non-resource products in exports Share of non-oil exports 45

40

35

30

25

20

15

10

5

0 Q12013 Q22013 Q32013 Q42013 Q12014 Q22014 Q32014 Q42014 Q12015 Q22015 Q32015 Q42015 Q12016 Q22016 Q32016

Figure 4. Share of the ruble and non-resource products in the Russian exports, % Source: Bank of Russia; FCS; authors’ calculations

Th e share of the ruble grew only by 7.2 pp therefore its share is signifi cantly less, (Figure 4). though the US dollar still remains the Th us, the ruble has the potential leading foreign exchange for settlements. for expansion of its usage in the export Settlements in rubles amount to at least settlements. Its share may be increased 25% of the total value of payments for without reference to the export of raw imported goods and services, while materials, let alone the export of oil and the share of euro being slightly higher gas, but this will imply promotion of (Figure 5). As was the case of the exports those industries that off er wider product settlements, the share of the ruble is diff erentiation9. International experience higher in the settlements for the goods shows that the share of national currency imported from the CIS states and the (e.g. in the receipts for the export of EAEU states. Here it exceeds 60%. pharmaceutical products) can reach 70% Nevertheless, the share of the ruble in to 80%. the settlements of imports from the EU is Unlike the exports, the Russian also high. It amounts to 26% of payments imports are more diff erentiated and on average. However, unlike the exports receipts, 9 Th e diff erentiation will be higher, where the the imports transfers do not expose a goods of diff erent sellers on the market are less clear tendency of growth of the ruble perfect substitutes. Th e diff erentiation is based on 41 the experience-based preferences of consumers transactions share. In trade with non- who consider diff erent brands as diff erent goods. CIS states as well as with the CIS states, USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

RUB share in the imports payments USD share in the imports payments EUR share in the imports payments 50

45

40

35

30

25

20 Q12013 Q22013 Q32013 Q42013 Q12014 Q22014 Q32014 Q42014 Q12015 Q22015 Q32015 Q42015 Q12016 Q22016 Q32016 Figure 5. Foreign exchange structure of payments for the Russian imports, % Source: Bank of Russia; authors’ calculations

the share of the ruble in the imports suppliers had begun being reluctant to transfers remains stable in general. Th is use the ruble in settlements ever earlier — can indicate weakness of market positions once the tendency of its reduction had of the Russian importers impelled to use come into view. foreign exchange as well as insuffi cient Th is process could be in some way attractiveness of the ruble. aff ected by tensions in relationships Strengthening the ruble could con- between Russia and the West countries in tribute to it signifi cantly. Its depre- the aft ermath of the Ukrainian crisis and ciation leads to reduction of the volume subsequent economic sanctions imposed and the share of the ruble in foreign trade. by the United States and their allies in Th is applies both to the exports receipts relation to some Russian top companies (Figure 6) and to the imports transfers and banks. However, once the ruble (Figure 7). started to strengthen, its share in foreign Th e fi rst quarter of 2015 is represen- settlements and volumes of transactions tative in this regard. Exchange rate of the were on the rise. New signifi cant ruble to the US dollar fell sharply by 32% depreciation of the ruble in Q1 2016 compared to the previous quarter. Th is once again caused reduction of the ruble resulted in reduction of the exports receipts volume and share in both the exports and volume by 27.9% and its share in the total imports settlements. amount of receipts by 29.6%. Th e same Such dependence can be considered fl uctuations emerged in the volume and as one more symptom of weakness of 42 share of the ruble in the imports transfers. Russian companies in the internal market Moreover, in the latter case foreign mentioned above. In foreign markets, RUSSIA’S DEAL ON PROMOTING THE REGIONAL STATUS OF THE RUBLE

Changes in Changes in the Changes in the RUB/USD rate share of the ruble volume of receipts in rubles in the exports receipts 50 40 30 20 10 0 -10 -20 -30 -40 Q22013 Q32013 Q42013 Q12014 Q22014 Q32014 Q42014 Q12015 Q22015 Q32015 Q42015 Q12016 Q22016 Q32016 Figure 6. Movements of the RUB to USD rate, volume and share of the ruble in the exports receipts from Russia, % Source: Bank of Russia; authors’ calculations national exporters making contracts in within the BRICS amounted to 7% and US dollars with the growth of its exchange 3.5% respectively. rate are able to get additional profi t in However, it is worth mentioning that rubles. On the contrary, in the internal the value of the ruble in the Russian exports market, setting prices on imported goods receipts within the BRICS increases faster than those with other countries. While the in US dollars in these circumstances leads share of the ruble in settlements with non- to cost growth and profi t reduction. Hence, CIS countries grew by 5.4 pp including investment capacity of Russian producers the EU countries by 6.8 pp, its share in also declines. payments from the BRICS states increased Th e use of the ruble in settlements by 8 pp Th e largest growth accounted for with the BRICS countries is inferior to the share of the ruble in receipts from those positions that the Russian currency India: from 1.1% in 2013 to 14.8% in 2015. generally occupies in the foreign trade of However, it began to decline in 2016. the country (Figure 8, Figure 9). Th ough the Th e share of the ruble in receipts for the share of raw materials in the Russian exports Russian exports to China grew from 1.5% to the BRICS countries is insignifi cantly less in January–September 2015 to 6.7% in than that in total exports of Russia, the US January–September 2016. On the other hand, the value of the dollar is dominant in bilateral settlements ruble in transfers for the imports from the between the BRICS states. It accounts for BRICS countries fell insignifi cantly. It was more than 80% of mutual trade. For the due to increase of the use of other BRICS fi rst 9 months of 2016, only 7.6% of the countries’ currencies in settlements, pri- Russian exports to the BRICS countries marily the Chinese renminbi. While in Q1 and 3.5% of the imports were settled in 2013 its share amounted only to 2.1% of 43 rubles, while the value of the ruble in trade the Russian imports transfers from China, USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Changes in Changes in the Changes in the RUB/USD rate share of the ruble volume of payments in rubles in the import payments 30 20 10 0 -10 -20 -30 -40 Q22013 Q32013 Q42013 Q12014 Q22014 Q32014 Q42014 Q12015 Q22015 Q32015 Q42015 Q12016 Q22016 Q32016 Figure 7. Movements of the RUB to USD rate, volume and share of the ruble in the import payments, % Source: Bank of Russia; authors’ calculations

RUB share in the exports receipts EUR share in the exports receipts Other currencies share USD share in the exports receipts in the exports receipts (right scale) 10 100

9 90

8 80

7 70

6 60 5 50

4 40

3 30

2 20

1 10

0 0

44 Q12013 Q22013 Q32013 Q42013 Q12014 Q22014 Q32014 Q42014 Q12015 Q22015 Q32015 Q42015 Q12016 Q22016 Q32016 Figure 8. Foreign exchange structure of exports from Russia to other BRICS countries, % Source: Bank of Russia; authors’ calculations RUSSIA’S DEAL ON PROMOTING THE REGIONAL STATUS OF THE RUBLE

RUB share in the imports payments EUR share in the imports payments Other currencies share in imports payments USD share in the imports payments (right scale) 16 95

14 90 12

10 85

8

6 80

4 75 2

0 70 Q12013 Q22013 Q32013 Q42013 Q12014 Q22014 Q32014 Q42014 Q12015 Q22015 Q32015 Q42015 Q12016 Q22016 Q32016 Figure 9. Foreign exchange structure of the Russian imports from other BRICS, % Source: Bank of Russia; authors’ calculations it grew to 15.8% of the total amount of ruble in the mutual trade between these transfers to China in Q3 201610. Th us, four countries in 2015 accounted for 10.5% the mutual trade of the BRICS countries of all payments (Figure 10). Th e largest assumes a rule, under which the exporter amount (14.8%) was reached in 2013. specifi es the transaction currency. While However, signifi cant depreciation in the seeking to mitigate foreign exchange risk, subsequent years led to reduction of its use and therefore of its share in settlements11. the exporter usually decides in favour of the national currency. Apart from bilateral trade, the ruble Development is used by third countries for settlements of trade in the RUB among each other, which in general on FX markets refl ects a high level of internationalization of the Russian currency. According to the statistics of the Interstate Bank since An important condition for using the 2005, the largest use of the ruble is fi xed ruble in international settlements is the in the settlements between Belarus and presence of a developed FX market. Such Kazakhstan as well as between Kyrgyzstan market allows quickly and with minimal and Tajikistan. In general, the share of the costs buying or converting rubles into

10 Th e Bank of Russia does not separate a share 11 See Payments providing mutual trade 45 of the Chinese renminbi in its statistics. "Other turnover // Interstate Bank. URL: http://www. currencies" column was taken as a reference data. isbnk. info/analytics_payments.html USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Volume of payments RUB share in the total volume of payments (right scale) 2O 16

18 14 16 12 14 12 10

10 8 8 6 6 4 4 2 2

0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Figure 10. Use of the ruble in mutual trade of Belarus, Kazakhstan, Kyrgyzstan and Tajikistan: volume (bn rubles) and share of the ruble (%) Source: Interstate Bank; authors’ calculations

any other currency. Currently, Russia has used for the USD/RUB currency pair with a suffi ciently large and liquid FX market calculations "tomorrow". (both the internal and external one) with In 2002, the average daily volume of a well-formed institutional structure and transactions in the internal FX market modern trade technologies. was 5.6 billion US dollars. Only 72% Th e internal FX market in Russia accounted for transactions with the ruble (Figure 11). Moreover, the main developed primarily as an exchange. instrument of trade in the interbank Moscow Interbank Currency Exchange market was the RUB/USD pair amounted (Moscow Exchange since 2012) was to 71.2% of the total volume of the FX established in January 1992 on which market or 99% of the volume of trade in trades were eff ected in auction mode until the ruble segment12. 1998. Unifi ed rates were established for all Completion of the liberalization of participants during the auction. In 1997, foreign exchange regulation gave a new MICEX proposed to the banks a system of burst of the development of the internal electronic lot trading allowed to conclude market. In 2007, the average daily turnover transactions during the entire operational increased by 88% in comparison with day at the current exchange rates. 2006 and amounted to 54.2 billion US Since July 1992, the Bank of Russia uses dollars. In July 2008, the market recorded the results of exchange trades to determine 12 See Main indicators of the Russian the offi cial exchange rate of the ruble Federation’s foreign exchange market turnover 46 (by methodology of the Bank of Russia) // against the US dollar. For that purpose, a Bank of Russia. URL: http://www.cbr.ru/ weighted average of 11:30 Moscow time is statistics/?PrtId=fi nr RUSSIA’S DEAL ON PROMOTING THE REGIONAL STATUS OF THE RUBLE

90 80

80 70

70 60 60 50 50 40 40 30 30 20 20

10 10

0 0 2002 2004 2006 2008 2010 2012 2014 2016 Volume of trade Share of Share of (right scale) instruments RUB/USD pair in rubles Figure 11. Internal FX market in Russia: volume (bn US dollars) and structure (%) Source: Bank of Russia; authors’ calculations a maximum trade volume of 84.1 billion overcome14. Against this background, US dollars per day. Trade in rubles for the Russian currency continued its other currencies beside the US dollar internationalization. Th e share of trans- also intensifi ed. As a result, the share actions with the ruble in the total volume of the RUB/USD pair slightly decreased to of currency transactions increased to 96.2% of the total volume of transactions 81%. Th e share of the RUB/USD pair (to 88.7% in 2013) continued to decrease due with the ruble in 2007 as well as to 94.6% to expansion of transactions with other in 200813. currencies. In 2009, the global fi nancial crisis However, in 2014, the positive deve- caused a decrease in the daily turnover lopment of the FX market stalled due in the Russian internal FX market to 40.2 to the infl uence of a number of external billion US dollars. In 2013, the average and internal factors. As a result, in 2016, daily trade volumes began to grow again the total turnover of trade in the Russian and amounted to 63.6 billion US dollars, internal FX market fell to 37 billion US as the consequences of the crisis were dollars per day, and the share of the RUB/ USD pair in the ruble segment rose to 13 See Main indicators of the Russian Federation’s foreign exchange market turnover 89.1% (73% of the total market volume). (by methodology of the Bank of Russia) // At the same time, the share of transactions 47 Bank of Russia. URL: http://www.cbr.ru/ statistics/?PrtId=fi nr 14 Ibid. USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

with the ruble slightly increased and sterling, Kazakh tenge, Belarusian amounted to 82% of total turnover. ruble, Hong Kong dollar and Ukrainian Serious changes underwent the hryvnia. However, the main turnover falls correlation between the exchange and on the RUB/USD pair the share of which interbank foreign exchange markets. amounts to 84.4% of the exchange trading Th e increased stability and strength in 2016. Another 13.1% accounted for the of Russian banks led to the fact that RUB/EUR pair16. Th us, the share of all the role of exchange trade in the ruble other instruments does not exceed 3%, segment declined signifi cantly. According which, of course, limits the possibility of to experts, in April 2008, over 80% of a wider use of the ruble in international conversion transactions with the ruble settlements. were eff ected between commercial banks in the OTC market (Mishina, 2016). Th e Th e maturity of the Russian FX market global fi nancial crisis facilitated a partial was evidenced by the decision taken in July return of transactions to the exchange. 2016 by the Emerging Markets Traders Aft er the introduction of economic Association and Chicago Mercantile sanctions in 2014, this trend has only Exchange to use the fi xing of Moscow intensifi ed. Exchange for settlements on futures On the one hand, many foreign and forward contracts for the Russian companies cut their limits on Russian currency instead of its own reference rate banks or completely stopped working (Fox, 2016). Th us, the participants of the with Russian clients. In late 2014 — early global fi nancial market demonstrated 2015, in conditions of high volatility increased confi dence in the mechanism of the ruble exchange rate, a number of for determining the ruble exchange rate foreign trading systems even stopped formed as a result of changes in the policy trading in ruble. At the same time, of the Bank of Russia related to the refusal Moscow Exchange traded in normal to maintain the FX band and the transfer mode, which facilitated the movement of of the ruble into free fl oat mode. transactions with the Russian currency Trade in ruble futures on the Chicago to the organized market. Th e growth of exchange trade is also promoted by the Mercantile Exchange began in April policy of the Moscow Exchange aimed 1998. However, it has been ceased already at providing foreign banks’ clients with in October 1998, because of the crisis. direct access to trading (Direct Market Only in 2003, CME began to quote ruble Access). futures again. Th e growth of foreign In general, the exchange turnover investors’ interest in the Russian currency increased from 96 trillion rubles in was facilitated by an increase in global oil 2009 to 330 trillion rubles in 2016, i.e. it prices and further liberalization of foreign grew more than 3 times for the specifi ed exchange regulation in Russia. Since period. At the same time, the average 2006, the ability to perform transactions daily trading volume exceeded 1.3 trillion with ruble-denominated instruments rubles in 2016. Th us, Moscow Exchange was provided by trading systems such as accounted for 53% of the Russian internal LavaFX Interbank (New York, the United 15 FX market . States) and ICAP EBS (London, the Currently, Moscow Exchange allows United Kingdom). Th e ruble is regularly making transactions for rubles with quoted by large international banks. eight currencies: US dollar, euro, pound Th rough Clearstream and Euroclear 48 15 Moscow Exchange Group Markets systems, the possibility to settle in rubles Statistics: Monthly trading volumes // Moscow Exchange. URL: http://moex.com/s867 16 Ibid. RUSSIA’S DEAL ON PROMOTING THE REGIONAL STATUS OF THE RUBLE

Table 1 Average daily volume of trade in the ruble abroad, USD million

2013 2014 2015 2016 April October April October April October April October United 34,400 23,200 28,700 27,500 18,900 13,400 17,700 20,100 Kingdom United n/a n/a n/a n/a n/a n/a 3,756 4,227 States Japan 890 380 220 70 80 130 160 230 Source: Monetary committees of London, Tokyo and New York Note: Regarding the United Kingdom and the United States — the volume of trade in the RUB/ USD pair; regarding Japan — against all currencies was received by international participants Reserve’s MP known as Quantitative of the Russian securities market. Easing, which contributed to the fl ow of According to the surveys held every capital from USD instruments to EMDE six months by London Foreign Exchange instruments including those denominated Joint Standing Committee, the volume in rubles. During the same period, the real of transactions with the Russian ruble in exchange rate of the Russian currency the UK demonstrated a constant increase. was strengthened due to high oil prices, For 6 years (from April 2008 to April which together resulted in an increase in 2013) it has grown from 10.1 billion US the ruble’s turnover in external markets, dollars to 34.4 billion US dollars, or in particularly in the UK. 2.4 times. Th e ruble’s share in the total However, in 2013, aft er the an- volume of FX transactions in the London nouncement of the beginning of the market increased from 0.6% to 1.4%17. tightening the United States MP, there was Transactions with the ruble are also fi xed a massive outfl ow of capital from EMDEs by the Bank of Japan, which includes and depreciation of many currencies (this them in its semi-annual surveys of the process is well-known as taper tantrum). FX market. Th e volume of transactions As a result, there was a decrease in the with the ruble in Tokyo is signifi cantly volume of FX trades, as it is calculated lower than in London, but even here, in US dollars. Th is trend was further it also showed rapid growth reaching intensifi ed in the following year. Th e a peak in April 2013 (890 million US outlined strengthening of the US dollar dollars in comparison with 10–20 million led to a decline in prices for commodities US dollars in 2009–10). However, the denominated in this currency (oil, gas, reduction followed next (Table 1). gold, metals etc.) that form the basis of Th is dynamic is mainly due to the exports of many developing countries. impact of external factors on the market As a result, their currencies continued to (internal factors play a secondary role). decline. Th e collapse in oil prices at the end Leading factor among them is the world of 2014 led to a depreciation of the ruble fi nancial cycle and a closely related cycle by more than 40%. of the United States Monetary Policy. An additional negative factor for the Th us, in the period 2008–13 there was ruble was the introduction of economic a progressive easing the US Federal and fi nancial sanctions against Russia by the United States and its Western 17 Th e London Foreign Exchange Joint allies. Fearing the huge penalties easily Standing Committee turnover surveys // Bank of 49 England. URL: http://www.bankofen-gland.co.uk/ enforced by the US authorities not only markets/Pages/forex/FXjsc/default.aspx in respect of their own, but also foreign USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

companies for their possible violation of London. Th e role of the US market, not the sanctions, many foreign banks and to mention the Asian market, is not yet fi nancial institutions have decided to great, which can hamper the progress minimize transactions with the ruble. of the ruble in foreign trade with APAC According to Russian experts, the countries. share of the off shore transactions with the Attention is also drawn to the relatively ruble fell in April 2015 to 9% of the total low share of the ruble in the total volume volume of the ruble market compared of FX transactions in external markets to 20% in October 2014 (Mishina, 2016). (0.4% in the US, 1% in the UK). Another However, in 2016, there was an interest in constraining factor for the use of the ruble the Russian ruble again. It is noteworthy in international settlements is the absence that since April 2016 the Monetary of direct quotations for most currencies. Committee of New York began to publish Th us, the markets of the EAEU data on transactions with the ruble, which countries usually use the US dollar or was not previously allocated to a separate euro as an intermediary when performing 18 column in the committee surveys . conversion operations with the ruble, Th e beginning of the restoration of which signifi cantly increases the cost interest in the Russian currency on global of transactions. Only in Belarus, trades markets is also refl ected in the recovery in the BYN/RUB pair have a relatively of growth in the volume of trade in high level of liquidity, and its volume has instruments denominated in the ruble. In stabilized at 15% of the total turnover of October 2016, the volume increased by foreign currency in the Republic. 13.6% in London and by 12.5% in New York compared with April 201619. Th e A similar situation takes place in the largest increase in average daily volumes BRICS countries. Direct quotes for the of ruble trade was demonstrated by the ruble are applied only to the Chinese Tokyo FX market, where it accounted for renminbi. Trade in this pair on the 43.8%20. interbank market of China began in Th us, the total volume of average daily November 2010, but its turnover still does turnover in the ruble market reached 62.6 not correspond to the scale of mutual billion US dollars in October 201621. More trade between the countries. According than 60% of this sum fall on the internal the offi cial representative of the State Russian market (Figure 12). About a Administration of Foreign Exchange, third of transactions with instruments Wang Chunying, the volume of trading denominated in the ruble, are made in of the RMB to the RUB amounted to 1.8 billion US dollars in 2016 or less than 18 See FX Volume Survey // Federal Reserve 3% of the total turnover between Russia Bank of New York: the Foreign Exchange Committee. URL: http://www. newyork-fed.org/ and China (TASS, 2017). On average, the fxc/volumesurvey/data.html daily volume of ruble trade in the Chinese 19 See Th e London Foreign Exchange Joint trading system slightly exceeded 7 milli- Standing Committee turnover surveys // Bank of on US dollars. England. URL: http://www.bankofengland.co.uk/ markets/Pages/forex/FXjsc/default.aspx; FX Vo- lume Survey // Federal Reserve Bank of New York: the Foreign Exchange Committee. URL: http:// www. newyorkfed.org/fxc/volumesurvey/data. Development html of the financial market 20 See Tokyo Foreign Exchange Market Committee. URL: http://www.fxcomtky.com/ Wide use of the ruble in international 50 index_e.html 21 Includes a certain dual account for settlements is impossible without a de- transactions between residents and non-residents. veloped market of fi nancial instruments RUSSIA’S DEAL ON PROMOTING THE REGIONAL STATUS OF THE RUBLE

Less than 1

7 Moscow Exchange

35 OTC market in Russia 32 OTC market in London

OTC market in New York 26 OTC market in Tokyo

Figure 12. Structure of global market of transactions made in the ruble, % Source: Bank of Russia; Monetary Committees of London, New York and Tokyo denominated in rubles and open access to institutions may open custodian accounts the market by foreign investors. at the National Depository Center. Back in 1996–98, foreign investors In fact, the opening of a Euroclear were granted limited access to transactions custodian account with the NDC took with Russian government securities. place only on December 27, 2012 and Aft er the fi nal stage of liberalization of Clearstream’s account was opened in foreign exchange regulation in 2007, non- February 2013. However, this delay residents were able to purchase state and did not aff ect the growing infl ow of corporate securities freely on the internal investments, due to which the share market. However, their activity in the of non-residents in the Federal Bonds public debt market was relatively small. market reached its maximum of 28.1% of As of January 1, 2012 non-residents’ the nominal value of outstanding bonds investments in the Federal Bonds in May 2013 (Figure 13). Further, the amounted to only 107 billion rubles (less share of non-residents declined slightly than 4% of their total volume)22. and stabilized at approximately 24%. In an eff ort to further attract investors, Foreign holders of Russian govern- the Bank of Russia decided to remove ment bonds reacted on the Ukrainian infrastructure barriers and allowed to crisis with a small sale resulted in the make OTC transactions with the Federal share of non-residents in the Federal Bonds through Euroclear and Clear- Bonds market dropped to 22.2% in March stream from the beginning of 2012. 2014. Nevertheless, it regained the former However, it did not cause much level again. enthusiasm among foreign investors. Th e introduction of economic san- Growth of non-residents’ investments in ctions against Russia led to new sales the Federal Bonds started only in Summer on the Federal Bonds market in July 2012, when it was decided that these 2014. Restraining measures regarding the access for Russian companies and 22 See Non-residents’ holdings of Russian banks to foreign fi nancial markets caused internal government debt (OFZ) and non- foreign investors to fear that Russia will residents’ market share // Bank of Russia. URL: 51 http://www.cbr.ru/ analytics/print.aspx?fi le=fi n_ not be able to maintain loans received stab/table_ofz.htm given the upcoming repayments to them USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

30 25 20 15 10 5 0 Jul. 2012 Jul. 2013 Jul. 2014 Jul. 2015 Jul. 2016 Jul. Oct. 2012 Oct. 2013 Oct. 2014 Oct. 2015 Oct. 2016 Apr. 2012 Apr. 2013 Apr. 2014 Apr. 2015 Apr. 2016 Apr. Jan. 2012 Jan. 2013 Jan. 2014 Jan. 2015 Jan. 2016 Figure 13. Share of the Federal Loan Bonds held by foreign investors, % Source: Bank of Russia; authors’ calculations

of signifi cant amounts of external debt. the Russian market. Already in July 2015, However, in December 2014, the panic their share in the Federal Bonds market that arose in the market was quickly exceeded 20%. By the end of 2016, it almost stopped by the actions of the Bank of returned to the pre-crisis level (25%). It Russia. As a result, no serious decrease in should be noted that the volume of the the volume of investments and the share Federal Bonds market increased by 1.5 of non-residents in the Federal Bonds times during this period (from 3,661 billion market occurred. rubles as of December 1, 2013 to 5,492 A sharp decrease in their share (by 5.5 billion rubles as of December 1, 2016). In pp to 18.7%) in January 2015 is due to an absolute terms, the share of non-residents increase in the volume of internal public increased from 911 billion rubles to 1,408 24 debt. Th e Government of the Russian billion rubles or by 54.6% . Federation was forced to replace to Despite the current economic sanc- domestic sources of fi nancing the external tions, non-residents continue to view ones that were inaccessible because of the Federal Bonds as an attractive asset that allows receiving a higher yield sanctions. than off ered in Western markets taking At the same time, the country’s into account the forecasted decline authorities refused in principle to use in infl ation. measures to restrict the export of capital. Th e Russian monetary authorities Stating the hopelessness of that path, the express a certain "concern on the Russian President Vladimir Putin noted signifi cant presence of non-residents" in during a Vladivostok’s meeting with inve- the Federal Bonds market. A massive exit stors on February 2, 2017 that he "did not of foreign investors from Russian bonds go so far as to limit the export of capital; market could lead to the market collapse. such proposals were made in the last year However, according to representatives of and the year before last; we did not do it the Ministry of Finance, the situation still 23 and we are not going to do it" . does not require any intervention. At the Th is approach helped to quickly restore same time, the Ministry emphasized again the positive attitude of foreign investors to 24 See Non-residents’ holdings of Russian 23 Meeting with potential investors in Far internal government debt (OFZ) and non- 52 Eastern Federal District // President of Russia: residents’ market share // Bank of Russia. URL: offi cial website. 2016. September 2. URL: http:// http://www.cbr.ru/ analytics/print.aspx?fi le=fi n_ en.kremlin.ru/events/president/ news/52798 stab/table_ofz.htm RUSSIA’S DEAL ON PROMOTING THE REGIONAL STATUS OF THE RUBLE

"there is no question of any measures of increased by 39%, and their share in the prohibition or restrictions" (Vestifi nance, total trading volume increased to 40%26. 2017). Since July 1, 2014, Euroclear and Ruble-denominated bonds of Russian Clearstream were authorized to settle transactions with equities of Russian companies cause less interest for foreign companies, which contributed to the investors. Despite of the fact that starting further expansion of non-residents’ from January 30, 2014 Euroclear and access to this market. To a certain extent, Clearstream started providing services this decision neutralized the negative to non-residents on settlements in the consequences for foreign investors from internal market of corporate bonds, their the imposition of economic sanctions share in the turnover on the secondary against Russia. In 2014, the volume market of Moscow Exchange remained at of net sales amounted to only 17.4 the level of 19%, as in 2013. In absolute billion US dollars, and their share in the total turnover of Moscow Exchange’s terms, it even decreased due to a decline stock market even increased to 46% in trading volume from 6.7 trillion rubles (Mesropyan, 2017). 25 in 2013 to 4.7 trillion rubles in 2014 . In 2015, the share of non-residents Such low activity of non-residents in the in turnover in the secondary market of corporate debt market denominated in equities decreased to 44%. Th is does not rubles is mainly due to the low number mean that they began to sell Russian of instruments qualifi ed for investment assets. According to Moscow Exchange’s purposes, which is generally a typical experts, in 2015, non-residents increased situation for most developing countries. their positions in Russian securities. Th eir net purchases amounted to 51.9 billion Th e participation of non-residents in rubles. the Russian stock market has always been However, facilitating the access of relatively signifi cant. In 2012, their share foreign investors to the Russian stock in the total trading volume on Moscow market did not lead to an increase in the Exchange was 37%. Nevertheless, the volume of trade on Moscow Exchange. In management of the exchange continued 2013, the turnover in secondary trading to pursue a policy of removing fell by 25.8% compared to 2012, and infrastructure restrictions on foreign reached 8.6 trillion rubles. In 2015, the investors’ access. decline in activity on the stock market resumed. Aft er an increase of 18.6% in In 2013, Moscow Exchange intro- 2014, the volume of secondary trades duced a more usual trading mode for non- decreased by 8.8% to 9.4 trillion rubles residents with settlements for the second in 2015, and remained approximately at day, which did not imply the need to the same level in 201627.Th e low liquidity pre-reserve funds for 100%. In addition, level of the Russian securities market foreign banks registered on the exchange is closely related to a small number were entitled to open direct access to of instruments that are traded on the trading for their clients. Most of them internal stock market (Mishina, 2011). used this opportunity (Mishina, 2016). In January 2016, only 252 companies As a result, in 2013, the volume of trading 26 See 2013 annual report // Moscow of foreign investors in Moscow Exchange Exchange. URL: http://www.moex.com/ru/ Report/2013/ 25 See Annual reports and reports on related- 27 See Moscow Exchange Group Markets 53 party transactions // Moscow Exchange. URL: Statistics: Monthly trading volumes // Moscow http:// moex.com/s1346 Exchange. URL: http://moex.com/s867 USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

were listed in Moscow Exchange. Th eir organized about 30 issues of Eurobonds number dropped to 245 by January 2017, amounted to 50 billion rubles. which was 10 companies more than in Another group comprised interna- January 2009. tional (JP Morgan Chase Bank) and major Moreover, Russian companies have regional banks (ABN Amro, Rabobank, low free fl oat. It can be confi rmed Danske Bank) that issued such Eurobonds indirectly by the relatively low listing primarily for their clients interested in requirements on Moscow Exchange. placing their accumulated rubles. It has to be a free fl oat of only 10% in A defi nite milestone in the deve- order to be included in the quotation list lopment of the off shore market of ruble- of the fi rst (higher) level. Where it falls denominated bonds was the access to it below 4%, the equity is transferred to by the Russian Government that attracted the second-level list. In fact, the median two tranches of 90 billion rubles for a value of the free fl oat for the equities of 96 period of 7 years at an average rate of companies traded on Moscow Exchange 7.5% in 2011. Th e current yield was even is 21% (authors’ calculations)28. For slightly lower than in the internal market. comparison, London Stock Exchange has However, despite the promise of Finance raised the requirements for a free fl oat Minister A.V. Kudrin, there was no from 15% to 25% since January 1, 2012. further issues, apparently, in order not to Th e level of internationalization create competition with the Federal Bond achieved by the Russian currency by market. the mid-2000s led to the appearance of Th e crisis in relations with the internationally traded debt obligations Western countries led to a sharp increase denominated in rubles. Th e fi rst was the in the risks associated with investing in Russian Bank of Development (currently, ruble-denominated assets, which was SME Bank) issued ruble-denominated refl ected in high interest rates for the credit linked notes for 2.5 billion rubles Russian currency. FX risk also showed in March 2005. In 2006, such debt a signifi cant increase. It took time for instruments were issued by eight Russian market participants to adapt to the new banks and companies for 45.4 billion policy of the Bank of Russia announced rubles (Gubeidullina, 2007). in November 2014 that it waived targeting By the end of 2011, 84 issues of ruble- the exchange rate of the ruble and switched denominated Eurobonds and credit targeting the infl ation instead. As a result, linked notes were registered for a total of the issue of off shore ruble-denomina- 350 billion rubles. However, more than ted bonds almost ceased. 80% of this market is accounted for by the Strengthening the ruble by the end of securities issued by Russian companies 2016 by almost 17% on the background of and banks (Kondratov, 2012). a relative recovery in oil prices contributed International and national deve- to a revival of interest both to the Russian lopment institutions (World Bank, EBRD, currency and to the ruble-denominated European Investment Bank, Nordic bonds. Investment Bank, KfW) were the most Th e volume of primary placements in active in the issue of ruble-denominated the internal debt market exceeded 5 trillion Eurobonds among non-residents. Th ese rubles in 2016 (Finam, 2017). At the institutions used them both to fund their same time, the issue volume of corporate operations in Russia and to develop a bonds almost doubled and amounted to new segment of the market. By 2011, they 3.9 trillion rubles. Th e off shore market also revived. In September 2016, Russian 54 28 See Data for free-fl oat index // Moscow Exchange. URL: http://moex.com/ru/listing/free- Railways placed ruble-denominated fl oat.aspx Eurobonds amounted to 15 billion rubles RUSSIA’S DEAL ON PROMOTING THE REGIONAL STATUS OF THE RUBLE for a period of 7 years with coupon non-resource products’ share in payment of 9.2%. Th e company informed Russian exports29. its readiness to continue borrowing in 4. Russia has a suffi ciently large and rubles on the international market in 2017 liquid FX market (both the internal (Rusbonds, 2017). A number of other and external one) with a well-formed Russian companies and banks announced institutional structure and modern similar plans. At the same time, the trade technologies. Foreign companies diff erence in interest rates may become are allowed to invest their rubles’ a certain deterrent to the revival of the liquidity in a large number of fi nancial off shore market of ruble-denominated instruments. bonds. Summary References 1. Fox M. CME set to replace Ruble We may summarize that the Rus- sian ruble has a quite high scale of reference rate to Moscow Exchange // internationalization. A share of the ruble in LeapRate. 2016. July 6. URL: http:// the total volume of payments on national www.leaprate.com/news/cme-set-to- foreign trade in goods and services with replace-ruble-reference-rate-to-moscow- other countries is comparable to the level exchange/ of Chinese renminbi: it amounted to 2. Gosupravlenie KNR: situaciya na 23% for Q3 2016, while the share of the mirovom rynke ne otrazitsya na valyutnom RMB dropped to 22% aft er the achieved sotrudnichestve s RF // TASS news agency. maximum (26%). 2017. January 30. URL: http://tass.ru/ Th e ruble is also used in mutual mezhdunarodnaya-panorama/3981175 settlements of Belarus, Kazakhstan, 3. Gubeidullina G. Modnie rubli // Ve- Kyrgyzstan and Tajikistan. At least 10% domosti. 2007. May 23. URL: http:// of that trade is currently carried out in the www.vedomosti.ru/library/ Russian currency. Moreover, the Russian ruble is a part of the Belorussian National articles/2007/05/23/modnye-rubli Bank’s international reserves. 4. Kondratov D. Stanovlenie rossijskogo To a certain extent, the Russian ruble rublya kak mazhdunarodnoj valyuti // is already acting as an international Ekonomicheskij zhurnal VSHE. 2012. currency in Eurasian region. And No. 3. P. 367–403. URL: http://ej.hse.ru/da there is a potential for its further ta/2013/02/28/1307112581/16_03_05.pdf internationalization. 5. Mesropyan M. Dolya inostrannih 1. Russian economy has adapted to investorov na rossijskom fi nansovom rynke low energy prices and demonstrates sustainable recovery. Th e Bank of ne sokraschaetsya // Vedomosti. 2016. Russia showed an effi cient policy when March 22. URL: http://www.vedomosti. waived targeting the exchange rate of ru/fi nance/ articles/2016/03/22/634550- the ruble and switched targeting the inostrannihinvestorov infl ation instead. 6. Minfi n nashel riski v vysokoj dole 2. Th ere are no restrictions on inostrancev // Vesti Ekonomika. 2017. transactions with the Russian currency (opening of accounts, cross-border 29 According to Russian Export Center, non- transfers, trade in securities etc.) resource products’ share has increased in the total exports amount by more than 11 per cent over 55 3. Expansion of settlements in rubles the past year (34.3% in 2015; and 38.2% in 2016, is facilitated by the increase of respectively). USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

February 22. URL: http://www.vestifi nance. ru/articles/81737 7. Mishina V. Rublevoe “importozame- schenie” vmesto “dollarizacii” // INP RAN. 2016. March 31. URL: http://ecfor.ru/wp- content/ uploads/2016/03/Rubl-i-EAES_ statya_022616_Mishina.pdf 8. Mishina V. Stanet li ruble valiutoj mezhdunarodnikh raschetov? // Bankovskoe delo. 2011. No. 1. P. 76–81. URL: http://www.mbka.ru/price/bank. delo_012010.pdf 9. OFZ — bezuslovnij favorit goda, no porencial ne ischerpan // Finam. 2017. January 18. URL: http://bonds. finam.ru/comments/item/bk-region-ofz- bezuslovnyiy-favorit-goda-no-potencial- ne-ischerpan/ 10. RZD interesni rublevie evrobondi, v 2017 g. мogut vipustit vechnie obligacii // RusBonds. 2017. January 18. URL: http:// www.rusbonds.ru/nwsinf.asp?id=4452651

56 INTERNATIONALIZATION OF THE RUPEE

Chapter 4

Internationalization of the Indian Rupee1

Th e GFG, for a variety of complex Rise of rupee trading reasons, prompted emerging markets to reconsider the role of their currencies We shift gears and look at market as global alternatives to the "big four" outcomes to get a sense of what drives currencies (US dollar, euro, British pound growth of currency markets and how and Japanese yen). internationalized is the rupee compared China’s policy pivot prompted policy to the BRICS currencies. For purposes of makers in India to consider the possibility cross-country comparison we use the BIS of internationalizing the Indian rupee. measure. Th e Reserve Bank of India commissioned Th e triennial Central Bank Survey two studies in 2010 and 2011 (Ranjan of Foreign Exchange and Derivatives and Prakash, 2010; Gopinath, 2011) Market Activity published by BIS is to examine the issues surrounding the currently the most comprehensive source internationalization of the INR. Both of information on trading in foreign studies recommended a cautious approach exchange markets (BIS, 2010, 2013, towards currency internationalization 2016). Th e survey provides consistent given the size of the Indian GDP, lower comparison on the size and structure of presence in global trade and partial FX and OTC derivatives markets, and has capital account convertibility. Th ey also been conducted every 3 years since 1995. add that while the rupee is a natural In the latest edition of the survey, data was contender for transitioning into a global collated for 53 currencies, encompassing currency, policymakers should start by instruments such as spot transactions, increasing the role of the INR in its local outright forwards, foreign exchange and region where the renminbi has taken a currency swaps and options. Central banks lead over the rupee. In spite of an early collect data from various banks and other interest in pursuing a policy of currency dealers within their jurisdictions, which internationalization, both the Indian is reported to BIS and used to calculate government2 and the RBI3 do not consider global aggregates. For the fi rst time since it to be a priority in the short to medium 2001, global FX trading declined between term. two consecutive surveys. Global FX turnover fell to USD 5.1 trillion per day in 1 Shekhar Hari Kumar, Ila Patnaik — National April 2016, from USD 5.4 trillion in April Institute of Public Finance and Policy. 2013. However, trading in EM currencies 2 See Internationalisation of Rupee // Business grew over this period with the renminbi Standard. 2016. May 7. URL: http://www.business- gaining market share (Moore et al., 2016). standard.com/article/government-press-release/ internationalisation-of-rupee-116050601065_1. Th e "big four" currencies maintained html their market shares and remain the 3 See Raghuram Rajan says no "big bang jump" only currencies which account for more for Rupee onto world stage // Th e Economic Times. than 10% in market share of all trades4. 2015. December 1. URL: http:// economictimes. indiatimes.com/markets/forex/ raghuram-rajan- 4 As of 2016; USD: 88%, EUR: 31%, JPY: 22%, 57 says-no-big-bang-jump-for-rupee-onto-world- GBP: 13% is on the other side of all the reported stage/articleshow/49998048.cms currency trades. USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

200

150 CNY RUB 100 INR BRL 50 ZAR

0 1995 2000 2005 2010 2015 Figure 1. Average daily turnover in BRICS currencies since 1995, USD bn Source: BIS triennial survey 2016, Table D11.3. All instruments, net-net basis

As per the BIS, the INR is ranked 20th on whether we consider Hong Kong by average daily turnover, across all FX an extension of the Chinese onshore instruments in April 2016. Th ere has market (Table 1). Only the RUB has more been a 20X increase in the average daily onshore trading than the INR and this turnover since 2001 in the INR (Figure 1). probably refl ects the eff ect of economic Figure 1 shows that trading in BRICS sanctions altering the location of trading. currencies grew on average at 20% every As a comparison, INR’s onshore share year between 2001–10. During this has been consistent at 41–44% between period the levels of trading in the BRICS 2013–16 whereas the RUB’s onshore currencies were also comparable with share increased from 47–56% in the same average daily turnover averaging between period. USD 20–50 billion. Aft er 2010, trading in If we compare the change in onshore the renminbi grows rapidly as China starts shares between 2013 to 2016 (Table 2), pursuing a policy of Internationalization. there is substantial heterogeneity in our Th e Brazilian real, South African rand sample of EM currencies. TRY, KRW, and Russian ruble grew faster than the MXN and CNY have become more INR aft er 2010 but they pare their gains internationalized over 2013–16 whereas aft er the taper tantrum of 2013. As ZAR, INR, RUB and BRL have gained of April 2016, the sum of the average onshore trading shares. Th e INR is daily turnover in the BRIS currencies is ranked 6th amongst peers by this proxy roughly equal to the daily turnover in the of currency Internationalization as well. renminbi. Ma and Villar (2014) use foreign ex- NDF markets change turnover as one of the pro- in the INR xies for identifying the extent of Internationalization of a currency, beca- Non-Deliverable Forwards diff er use it helps shed light on the currency’s from outright forward contracts where use by non-residents. Th erefore, as the counterparties enter into a binding a currency internationalizes, we can contract for a physical exchange of funds. expect to see greater trading to take place NDF contracts while similar in nature, in off shore fi nancial centers. By this impose no such restriction, allowing 58 metric India ranks 6th or 7th amongst counterparties to settle profi ts or losses on comparable EM currencies depending a notional amount without any physical INTERNATIONALIZATION OF THE RUPEE

Table 1 Location of currency trading by EM currency, %

Location INR TRY ZAR RUB MXN KRW BRL CNY Brazil 0 0 0 0 1 0 25 0 China 0 0 0 0 0 0 0 22 Hong Kong SAR 8 1 1 0 1 16 2 31 India 44 0 0 0 0 0 0 0 Korea 0 0 0 0 0 38 0 0 Mexico 0 16 0 0 0 Russia 0 0 56 0 0 0 Singapore 24 2 2 0 1 21 0 17 South Africa 0 0 24 0 0 0 Turkey 0 13 0 0 0 United Kingdom 13 61 44 29 29 13 21 16 United States 8 15 19 8 43 9 45 9 ROW 391079365 Total 100 100 100 100 100 100 100 100 Source: BIS triennal survey, 2016 . Table 2 Change in percentage of onshore trading since 2013, % Currency 2013 2016 Change INR 41 44 7.32 TRY 19 13 -31.58 ZAR 23 24 4.35 RUB 48 56 16.67 MXN 20 16 -20.00 KRW 53 38 -28.30 BRL 20 25 25.00 CNY (Including HK) 57 53 -7.02 Source: Authors’ calculations . exchange of funds. Th ese contracts are 2013). Th is fi gure has grown by 5.3% in usually cash settled, denominated in dollar terms to 134 billion in 2016 (BIS, USD, and traded on currencies which 2016). Four BRICS currencies (excluding are not readily available to trade globally. South Africa) contributed 36% to this EM currencies, characterized by partial turnover in 2016, down from 42% in 2013. capital account convertibility, form a Th e decline has mainly been on account of bulk of NDF markets mainly because China’s decreasing share (approximately participants engaged in trade and capital 40% decline) of NDF markets, with their fl ows with these countries face barriers off shore NDF markets being replaced in access to domestic foreign exchange with off shore, deliverable forwards owing markets. to renminbi’s internationalization in the In 2013, the estimated average daily recent years. turnover of NDF markets was USD 127 India’s turnover in the NDF market billion, accounting for 19% of all outright was reported to be at USD 16.5 billion in 59 forwards contracts traded globally (BIS, 2016, up 16.7% from 2013 in FX adjusted USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

10, 000 CN

BR 2, 000 RU KR MX

GDP 2015 ID TR 500 PL CO TH ZA PH GL MY 200 PE CZ HU 5 10 20 50 100 200 Daily Turnover 2016 Figure 2. Drivers of FX market turnover in EM currencies (USD bn): GDP (USD bn) Source: BIS triennial survey (2016), Table D11.3; WDI

PE 1.00 HU KR

Openness CZ RU 0.50 GL BR MX CO ID PL ZA TR TH 0.20

PH MY 0.10 CN

0.05 IN 5 10 20 50 100 200 Daily Turnover 2016 Figure 3. Drivers of FX market turnover in EM currencies (USD bn): Openness Source: BIS triennial survey (2016); Fernandez et al. (2015)

terms (BIS, 2016). Th e INR/USD NDF nover of USD 17 billion underscores the instrument trades exclusively in off shore growing demand for the rupee abroad. markets, forming approximately 60% Th e highly liquid off shore NDF market of all turnover in INR off shore markets. is a symptom of growing international 60 Comparison with the onshore currency interest in a currency that is not fully derivatives market’s average daily tur- convertible. Cut-off from access to the INTERNATIONALIZATION OF THE RUPEE domestic INR markets, participants ween these two variables is positive compensate for their forex risk by trading and signifi cant. By this metric, INR, heavily in the off shore NDF markets. BRL, RUB and RMB have smaller forex Historical empirical evidence seems market turnover than predicted by their to suggest that the onshore-off shore GDP level. We look at the relationship forward premium gap for the INR was between level of capital account openness always lower than the RMB (Hutchison as proxied by the Fernandez et al. (2015) et al., 2012), suggesting greater fi nancial measure and forex market turnover in integration in INR markets as compared Figure 3. Th e Fernandez et al. (2015) to the RMB (Ma and McCauley, measure is rescaled from 0 to 1 with 2013). Th is may be changing as China zero meaning a completely closed capital internationalists the RMB and allows for account and one meaning a completely greater participation of non-residents in open capital account. Th e correlation an off shore deliverable forward market between forex market turnover and (McCauley and Shu, 2016). capital account openness is negative and insignifi cant. Th is is primarily because What determines INR and RMB are large EM currencies forex market turnover? who are signifi cantly in spite of being fairly closed capital account economies. Forex market turnover is a function However, the negative and insignifi cant of EM fundamentals like size of the correlation is opposite to what is predicted economy, share in global trade, fi nancial by the literature. depth and capital account openness Figure 4 evaluates the relationship (Eichengreen and Kawai, 2015). He and between volume of trade proxied by the Yu (2016) fi nd that share of a country value of imports and exports from the in world trade has a clear positive eff ect WDI and forex market turnover. Th e on the turnover of its currency in FX relationship between these variables is markets, but the eff ect of capital fl ows positive and signifi cant. By this metric, appears insignifi cant. Th ey also fi nd that the BRL and ZAR have larger forex share of currency trade is signifi cantly market sizes as predicted by their volume associated with the fi nancial depth of trade whereas the INR, RUB and measured by size of stock market size RMB have smaller forex markets. We to GDP. He and Yu (2016) take the full fi nally evaluate the relationship between sample of BIS reporting currencies while fi nancial depth as proxied by market conducting their analysis. We restrict our capitalization to GDP to forex market sample to the 19 largest EMs5 in the BIS turnover in Figure 5. We fi nd a negative reporting group and look at correlations and insignifi cant correlation between between forex market size and various these two variables, similar to capital fundamentals. Th is exercise pins down account openness. which fundamentals are important for Th is parsimonious correlation exer- growth in EM forex market turnover. cise tells us that level of GDP and Moreover, it helps us evaluate whether volume of trade are the most important forex market turnover is higher or lower fundamentals driving EM forex market compared to the level predicted by the turnover. Th is is a little diff erent to country fundamental. advanced countries where fi nancial Figure 2 shows the relationship depth and capital account openness are between level of real GDP and forex signifi cant factors determining forex market turnover. Th e correlation bet- market turnover. Th is is most likely due to the fact that a majority of EM currency 61 5 See Appendix for the list of countries. demand comes through current account USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

5, 000 CN

2, 000 KR RU MX TH BR 500 ID MY PL TR CZ Volume of Trade 2015 Trade of Volume HU ZA PH GL CO 100 PE 5 10 20 50 100 200 Daily Turnover 2016 Figure 4. Drivers of FX market turnover in EM currencies (USD bn): Trade turnover (USD bn) Source: BIS triennial survey (2016), Table D11.3; WDI

% MY ZA GL PH TH 100 KR CO IN BR 50 PE ID RU MX CN PL TR

20 CZ HU

5 10 20 50 100 200 Daily Turnover 2016 Figure 5. Drivers of FX market turnover in EM currencies (USD bn): size of fi nancial market (MCAP to GDP, %) Source: BIS triennial survey (2016), Table D11.3; WDI

linkages rather than fi nancial account and RMB, as forex market turnover is linkages given the presence of capital lower than what is predicted by level of controls in large EMs. Th e presence GDP and volume of trade. Th is is also 62 of capital controls seems to dampen indication that these currencies have currency demand in the case of INR additional room to grow as international INTERNATIONALIZATION OF THE RUPEE currencies once there is grea- countries are used as reserve currencies in ter capital account liberalization (Ma and their economic area of infl uence whereas Villar, 2014). the RMB had much wider usage in reserve assets. Role of INR as Table 4 shows the magnitude of re- international currency serve assets holding in various currencies. By this metric the INR is ranked second A. Official sector last amongst all major currencies. Th e We switch gears and evaluate the volume of INR held as reserve assets has internationalization of the rupee in terms increased from 2013 to 2014 to around a of its roles as an international currency in billion dollars. Th ere is some anecdotal the tradition of Chinn and Frankel (2008) evidence that Indian rupee is accepted and Ito (2016). We fi rst look at the role in Singapore, Malaysia, Indonesia, Hong of the INR as an international currency in the offi cial sector. According to the Kong, Sri Lanka and the UK. Th e Central IMF Currency Composition of Offi cial Bank of Nepal, Nepal Rastra Bank, also Foreign Exchange Reserves, as of Q2 holds Government of India Treasury 2016, around 93% of all forex reserves are Bills (Ranjan 2010). Th e INR is also a denominated in the "big-four" currencies. historical outlier, given the fact that INR Th e BRICS currencies are part of claims was legal tender in Qatar, Bahrain, UAE, in other currencies which at best amount Kuwait, Oman and Malaysia till the mid to 3% of global reserve holding. As part of 1960’s (Ranjan and Prakash, 2010). the inclusion of the RMB in the Standard Another mode of offi cial sector cur- Drawing Rights, COFER will report rency internationalization goes through breakdown of RMB reserves from Ap- bilateral swap lines. Aft er the GFC, use ril 20176. To supplement the COFER, the IMF of swap lines between central banks has conducted an ad-hoc survey of 130 become a popular mode for sharing dollar member countries on their holding of funding (liquidity) risk as well as currency currencies in offi cial foreign currency internationalization. Th e RBI has utilized assets (IMF, 2015). Th e country level the swap line channel to mitigate dollar information was classifi ed but the IMF funding risks rather than build bilateral released summary information regarding ties to internationalize the rupee. Table the global distribution of reserve assets 5 shows bilateral swap arrangements along with their associated magnitudes. entered into by the RBI. Th e RBI has Table 3 shows that 6 countries claimed four swap lines of note, out of which 3 that they use INR in their offi cial sector are active. Th e swap line with the Bank of assets as of 2014. Only the BRL has lower reserve asset penetration than the Japan is now inactive. Out of the 4 swap INR. Th ere is a clear diff erence between lines, the swap line with the Central bank the RMB and the BRIS currencies. BRIS of UAE is the only one denominated in local currency7. All the other swap lines 6 See Chinese Renminbi to be Identifi ed have a dollar transaction leg. in the IMF’s Currency Composition of Foreign Exchange Reserves // IMF. Press Release No. 16/90. 2016. March 4. URL: http://www.imf.org/en/ News/Articles/ 2015/09/14/01/49/pr1690 or 7 See RBI and Central Bank of UAE sign MoU Separate Identifi cation of the Chinese Renminbi to consider Currency Swap Agreement // Reserve in the COFER survey // IMF. Staff Report. 2016. Bank of India. 2016. February 12. URL: http:// 63 March. URL: http://www.imf.org/ exter-nal/np/ www.rbi.org.in/Scripts/BS_ PressReleaseDisplay. pp/eng/2016/021816.pdf aspx?prid=36229 USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Table 3 Role of INR in international reserves, distribution 2013 2014 Total Currency Holdings 130 130 US dollar 127 127 Pound sterling 108 109 Euro 109 108 Japanese yen 87 88 Canadian dollar 84 85 Australian dollar 79 78 Swiss franc 73 69 Swedish krona 45 48 Norwegian krone 45 40 Chinese renminbi 27 38 New Zealand dollar 27 29 Singapore dollar 16 18 South Africa rand 11 12 Russian ruble 5 8 Indian rupee 4 6 Brazilian real 5 5 Other currencies 81 80 Source: IMF Survey on the Holdings of Currencies in Offi cial Foreign Currency Assets, 2015

B. Use of INR a sub limit of USD 33 billion for sovereign by private actors debt and USD 51 billion for corporate Currency substitution and investment debt. Prior to 2016, most of the FPI-debt India has a liberalized framework for limit for sovereign debt was fully utilized foreign portfolio investment since the with some room in the corporate bond notifi cation of the Foreign Institutional segment. Given the changing stance Investor framework8 in 1995. Th e Indian of global monetary policy, there has securities regulator, Securities and been a sell-off in EM bonds and current Exchange Board of India liberalized the utilization of the FPI-debt stands at foreign investment framework recently in 67% for both sovereign and corporate 11 July 20149. Over 1000 new foreign investors segment . Th e INR is actively used for registered with SEBI during the period currency substitution and investment. from June 2014 to August 2015, marking a 12% increase in the number of investors Rupee-denominated registered with SEBI. On average, 19– bonds 20% of Indian equities are held by foreign investors10. Foreign portfolio investment Liberalization of the external com- in debt is subject to limits. Th ere is total mercial borrowings framework in 201512 cap of USD 84 billion for FPI-debt with and 2016 allowed Indian corporates to issue INR-denominated bonds overseas. 8 See Foreign Institutional Investors Regulations // Securities and Exchange Board of 11 See Debt Utilisation Status // National India. 1995. URL: http://www.sebi.gov.in/acts/ Securities Depository Ltd. URL: http://www.fpi. fi iregu2009.pdf nsdl.co.in/Reports/Re-portDetail.aspx?RepID=1 9 See Foreign Portfolio Investors Regulations // (for the latest number) Securities and Exchange Board of India. 2014. URL: 12 See External Commercial Borrowings http://www.sebi.gov.in/cms/sebi_data/attach- (ECB) Policy - Issuance of Rupee denominated 64 docs/1389083605384.pdf bonds overseas // Reserve Bank of India. 2015. 10 Market capitalization of Indian equities: September 29. URL: http://www.rbi.org.in/Scripts/ USD 1.5 trillion, FPI-Equity: USD 300 billion. Notifi cationUser.aspx?Id=10049 INTERNATIONALIZATION OF THE RUPEE

Table 4 Role of INR in international reserves, magnitude 2013 2014 Amount, Per cent Amount, Per cent USD million of total USD million of total Total Holdings in Currencies 6,779,830.42 100.00 6,738,534.06 100.00 SDR Basket Currencies 6,276,718.91 92.58 6,214,838.24 92.23 US dollar 4,158,921.34 61.34 4,290,575.54 63.67 Euro 1,603,466.98 23.65 1,417,328.09 4.03 Pound sterling 287,966.45 4.25 274,564.80 4.07 Japanese yen 226,364.14 3.34 232,369.81 3.45 Non-SDR Basket Currencies 503,111.51 7.42 523,695.81 7.77 Australian dollar 151,026.62 2.23 142,451.37 2.11 Canadian dollar 133,863.09 1.97 133,869.60 1.99 Chinese renminbi 45,358.87 0.67 74,611.87 1.11 Swiss franc 16,077.82 0.24 15,365.62 0.23 New Zealand dollar 16,805.46 0.25 15,213.97 0.23 Swedish krona 13,819.59 0.20 13,224.57 0.20 Norwegian krone 13,956.93 0.21 12,050.16 0.18 Singapore dollar 4,388.19 0.06 3,912.38 0.06 Brazillian real 3,416.08 0.05 3,335.65 0.05 South Africa rand 2,687.69 0.04 3,140.54 0.05 Indian rupee 495.23 0.01 1,000.11 0.01 Russian ruble 360.81 0.01 355.97 0.01 Other currencies 100,891.13 1.49 105,164.00 1.56 Source: IMF Survey on the Holdings of Currencies in Offi cial Foreign Currency Assets, 2015

Th ese bonds are commonly referred to as a billion dollars each (LSE, 2016). Th e "Masala bonds". Th e rupee-denominated uptake of Masala bonds is also low as a bond is an attempt to shield issuers from percentage outstanding international currency risk and instead transfer the debt securities issued by Indian national risk to investors buying these bonds. entities. Th e currency risk is borne by the investor and hence, during repayment Invoicing and of bond coupon and maturity amount, settlement of trade if rupee depreciates, RBI will realize a in INR marginal saving. Many commentators have pointed out the issuance of rupee- Currency invoicing in trade is an denominated bonds overseas is a major important fi rst step for any national step in internationalizing the INR. As currency to become an international of November 2016, there are 13 active currency. Local currency invoicing of Masala bonds listed in LSE, raising trade in the rupee is less than 2.5% of total USD 2 billion. Out of these 13 bonds, trade as of the last release of currency 10 Masala bonds have been raised by invoicing data by the RBI13 in 2014. multilateral organizations and remaining 13 See Foreign Trade Statistics // Reserve Bank 65 3 by Indian corporates. Both multilateral of India. 2014. August 06. URL: http://rbi.org.in/ organizations and corporates have raised Scripts/BS_PressRele-aseDisplay.aspx?prid=31788 USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Table 5 RBI swap lines Counterparty Last renewal Size, USD bn Objective Mitigation of US dollar Bank of Japan 2014-01-01 50 funding risk Mitigation of US dollar SAARC countries 2016-02-01 2 funding risk Bilateral swap line, management Central Bank of UAE 2016-02-01 - of INR/AED mismatch BRICS (Contingent Mitigation of US dollar 2015-07-01 18 Reserve Arrangement) funding risk Source: RBI (2014)

Table 6 Invoicing of exports, % Currency 2008–09 2009–10 2010–11 2011–12 2012–13 Pounds sterling 2.77 2.81 2.47 2.31 2.31 US dollar 84.06 84.75 86.41 87.01 88.41 Japanese yen 0.48 0.35 0.22 0.26 0.15 Euro 10.85 10.13 8.88 8.14 6.97 All other Currencies 1.84 1.96 2.02 2.28 2.16 Source: RBI (2014) Table 7 Invoicing of imports,% Currency 2008–09 2009–10 2010–11 2011–12 2012–13 Pounds sterling 0.89 0.66 0.71 0.5 0.42 US dollar 86.06 83.91 85.38 88.67 86.06 Japanese yen 2.3 1.98 1.73 1.41 1.47 Euro 9.82 12.61 11.13 8.29 9.44 All other Currencies 0.93 0.84 1.05 1.13 2.61 Source: RBI (2014)

90 80 70 60 50 40 30 20 10 0 US Swiss British Chinese Rus- Cana- Indian Japa- Turkish Other DK/NA dollar frank pound renminbi sian dian rupee nese lira ruble dollar yen 66 Figure 6. Indirect evidence of rupee invoicing, % Source: Langedijk S., et al. (2016) Note: DK/NA denotes "Dont'know/No answer" INTERNATIONALIZATION OF THE RUPEE

% 60

50

40

30

20

10

0 Large Competitors Sector Exchange risk Other DK/NA recipient use other characteristics management country currencies Figure 7. Factors driving utilisation of LCY in invoicing, % Source: Langedijk S. et al. (2016) Note: DK/NA denotes "Dont' know/No answer"

Most of the trade invoicing in India goes RBI. As of the writing of this paper, only through USD and EUR (Table 6). Bhutan and Nepal have access to direct Th is structure of invoicing is a refl ection invoicing and settlement of their trade in of the transaction costs faced by external rupees. For all other countries, as per the trade partners and local traders in invoicing last notifi cation issued by the RBI15, trade trade in local currency. Around 22% of from and to India may be invoiced in all Chinese trade is now settled using the "freely convertible currencies" or rupees. 14 RMB , which is down from a high of 26% Amongst the BRICS currencies, only prior to the RMB’s devaluation. the South African rand is considered a Goldberg and Tille (2008) and Ito and freely convertible currency by the RBI. Chinn (2014) argue that hedging costs are Th is limits the invoicing and settlement a primary driver aft er "size" of a country in possibilities of trade partners who do not explaining local currency use in invoicing. have freely convertible currencies. Bilateral Th is assertion is backed by recent survey trade deals provide a work-around and evidence from European traders (Langedijk allow for limited local currency settlement. et al., 2016). Th e survey fi nds that only a President Putin and Prime Minister small number of fi rms invoice in currencies Modi announced a push towards bilateral (Figure 6) outside the "big four" and the settlements in the ruble and rupee during levels of local currency invoicing of trade President Putin’s visit in December 2014. Aft er initial excitement surrounding this in RMB and INR are similar for European arrangement limited bilateral banking fi rms. Moreover, hedging costs are the presence, small volume of trade between primary determinants of local currency use both countries, limitations in availability aft er size of recipient country (Figure 7). of hedging instruments and continued In spite of this facility being proposed depreciation of the INR/RUB currency in 2012, it has not been notifi ed by the 15 See Notifi cation FEMA 14(R)/2016-RB // 14 China: Renminbi stalls on road to being a Reserve Bank of India. 2016. May 02. URL: http:// global currency // Financial Times. 2016. Decem- rbidocs.rbi.org.in/rdocs/notifi cation/ PDFs/FNT 67 ber 11. URL: http://www.ft .com/content/e480f 14RBBC96EA1D8574325AF4314261D E5133A. d92-bc6a-11e6-8b45-b8b81dd5d080 PDF USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

pair against the dollar16 have eff ectively world in terms of foreign trade and put a stop to bilateral settlement17. international capital fl ows. Key benefi ts According to (non-publicly available of internationalization of rupee include data) SWIFT18, in April 2016 80% of savings on foreign exchange transactions trade to India was settled in USD. Th is for Indian residents, reduced foreign followed by 7.2% in INR, 6.3% in EUR exchange exposure for Indian corporate, with the remaining 6.5% split over reduction in dependence on foreign all other currencies. Th is percentage exchange reserves for balance of payment share indicates approximately USD stability etc. One of the important drivers 50–70 billion of trade settled in rupees. for internationalization of a currency is However, the INR does not make the top the countries share in global merchandise 20 international settlement currency list and commercial services trade. India’s (according to SWIFT) indicating that percentage share in the global trade is there is a great potential in improving still on the lower side and it limits the settlement of trade using the INR. pricing ability of domestic businesses Th e INR is more actively used by in Indian rupee. Moreover, the share private actors than the offi cial sector. Th e of Indian rupee in the global foreign bulk of INR’s international utilization exchange market turnover at present comes from the usage of INR in currency is also very low. Internationalization substitution and investment activity by of Indian currency would also require private actors. Table 8 summarizes INR’s full capital account convertibility. As a role as international currency across policy, we have followed a gradual and both offi cial and private sectors and we cautious approach in opening up the can see that it has a negligible role as an capital account. Th e capital account international currency. is being progressively liberalized in accordance with the evolving macro- Looking ahead economic conditions and requirements of the Indian industries, individuals and Internationalization of rupee will fi nancial sectors19. facilitate greater degree of integration It is more likely that Indian poli- of Indian economy with rest of the cymakers will choose a gradual move towards internationalization in the medium term. As of writing this paper 16 See Russia and India move to settle in own currencies // Russia Beyond. 2015. November 19. India only satisfi es the size of GDP and URL: http://www.rbth.com/economics/ fi - political stability pre-conditions for nance/2015/11/18/rusia-and-india-move-to- currency internationalization. settle-in-own-currencies_541991 Restrictions on currency conver- 17 Given evolving global macroeconomic tibility, both on the current and capital conditions and expectations of US dollar appreciation, India’s foreign trade policy for account hamper growth of INR as a 2015–20 does not mention any explicit incentive global currency. Th e framework for for LCY invoicing and settlement. MoF note exchange controls in India comes from F.No.20/15/2012 — BO.II was proposed at a time the Foreign Exchange Management Act, when the rupee was relatively stronger compared to the current macroeconomic situation. See which was passed in December 1999 Foreign Trade Policy [1st April, 2015 – 31st March, and enacted in 2000. FEMA categorizes 2020] // Government of India. URL: http://dgft . transactions into current account and gov.in/ exim/2000/ft p2015-20E.pdf 18 See Rapoza K. Sorry British Pound, India 19 See Internationalisation of Rupee // Busi- Prefers Chinese Yuan In Trade Deals // Forbes. ness Standard. 2016. May 7. URL: http://www. 68 2016. May 27. URL: http://www.forbes.com/sites/ business-standard.com/article/government- kenrapoza/ 2016/05/27/india-increasingly-using- press-release/internationalisation-of-rupee- chinese-yuan-in-trade-deals/ 116050601065_1.html INTERNATIONALIZATION OF THE RUPEE

Table 8 Roles of INR as an international currency Function of Governments Private actors money Currency substitution and International Reserves Store of value investment Negligible FPI framework Vehicle currency for FX Invoicing trade and fi nancial Medium of intervention transactions exchange None Negligible Denominating trade and Anchor for local currency pegging Unit of account fi nancial transactions None Negligible capital account transactions and has both residents and non-residents from specifi c rules and restrictions for across using the rupee for current account classes of individuals and investors; transactions. based on residence, size of transaction, As far as the capital account is instruments used, tenor of instrument concerned there is a large framework of and vehicle currency. For the purposes of controls split by residency, instrument, India’s ascension to the WTO, the rupee is transaction size and investor category. a fully convertible currency on the current Th e power to regulate capital account account. However, as we described in the transactions currently vests with the previous section, simple transactions like RBI. Th is power has been conferred on it realization of payments for exports and by Section 6(3) (b) of FEMA. A general imports cannot be in rupees unless its overview of the framework is as follows specifi cally approved. Current account (Patnaik and Shah, 2012; Sengupta, 2016): transactions exceeding USD 250,000 • Outward fl ows by fi rms: Outbound 20 for individuals require RBI approval. FDI by a fi rm is capped at a multiple 21 Rupee accounts cannot be held abroad of its net worth; and therefore overseas cash settlement • Foreign Banks: RBI restricts the in rupee is not currently possible. Th e growth of foreign banks by permitting documentary requirements along with delays in approvals dis-incentivize all foreign banks, put together, to open 20 branches a year; 20 See Master Direction - Liberalised • Foreign borrowing by fi rms: Maturity Remittance Scheme (LRS) // Reserve Bank of India. 2016. January 1. URL: http://rbi.org.in/ of loan, amount, interest rate, end-use Scripts/Notifi cation User.aspx?Id=10192 and the sector to which the debtor 21 Rupee Drawing arrangements exist with fi rm belongs, are prescribed. Th e Gulf countries, Hong Kong, Singapore, Malaysia aggregate borrowing by all fi rms in a and other FATF compliant countries. Th ese year is subject to a ceiling; accounts can be used for channeling cross-border inward remittances into India primarily on private • Debt investment by foreign portfolio account up to INR 1,500,000 per transaction. Th ese investors: Th e aggregate investment accounts cannot be used for trade settlement, even though in theory they may be utilised to do so. See by all foreign investors is subject to Master Direction – Opening and Maintenance of one ceiling for government bonds, Rupee/Foreign Currency Vostro Accounts of Non- and another for corporate bonds; resident Exchange Houses) // Reserve Bank of 69 India. 2016. January 1. URL: http://www.rbi.org. • Equity investments by foreign portfolio in/ Scripts/BS_ViewMasDirections.aspx?id=10205 investors: Only registered "foreign USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

portfolio investors" are permitted registration26. Th is was followed a year to buy shares in India. Th eir later by announcement of a medium investments are subject to sectoral and term framework27 for investment in fi rm level ceilings; onshore rupee-denominated govern- • FDI: Foreign ownership in certain ment securities. Th e key announcement sectors (e.g. telecom, insurance, was that limits for FPI investment in 28 banking) is capped at various levels. the Central Government securities will be increased in phases to reach Th e FEMA reform process in terms 5% of the outstanding stock by March of both current and capital account 2018 along with limit enhancements transactions has tended to drift towards announced every March and September. greater openness. Current account out- Th is announcement along with the fl ow restrictions on individuals have been introduction of the FPI framework was eased in 4 incremental steps22 between made to provide foreign investors a 2004–15 with the limits being increased more predictable investment regime in from USD 25,000 to USD 250,000 over rupee-denominated assets. Th is marks the 11 year period23. In terms of foreign the fi rst instance of the RBI committing portfolio investment, India moved to a to a glide-path or a medium term plan unifi ed portfolio investment framework for capital account liberalization similar for institutional investors, nonresident to PBC’s announcements regarding the individuals and venture capital funds renminbi. Th e ECB framework also saw in 201424. Recent developments in the large scale changes in 2015 with the FPI framework for investment in rupee- introduction of off shore rupee trade denominated bonds and the external credit29 and off shore rupee-denominated commercial borrowing framework for bonds30 in September. Th ese changes are foreign borrowing by fi rms gives us some an integral part of internationalizing the insight about the current state of the rupee and allow for deepening of rupee capital account reform process. liquidity in off shore centers. Th is was Th e introduction of the FPI25 frame- work marked a structural change in 26 See Gupta R. India: Foreign Portfolio Investment In India: SEBI Creates A New Class regulation of inward portfolio fl ows. Of Investors // Mondaq. 2014. 3 September. URL: Th is allowed for rationalization of http://www.mondaq.com/india/x/ 338010/Commo documentary requirements, merging dities+Derivatives+Stock+Exchan ges/Foreign+Po rtfolio+Investment+In+India+SEB I+Creates+A+ of investor categories, clarifi cations New+Class+Of+Investors on tax treatment and a reduction in 27 See Investment by Foreign Portfolio processing time for foreign investor Investors (FPI) in Government Securities // Reserve Bank of India. 2015. October 6. URL: 22 Th ese limits were partially reversed during http://www.rbi.org.in/scripts/NotificationUser. the taper tantrum. aspx?Id=10059 23 See Master Direction — Liberalised 28 Additionally, a separate limit for investment Remittance Scheme (LRS) // Reserve Bank of by all FPIs in the State Development Loans was India. 2016. January 1. URL: http://rbi.org.in/ also announced, to be increased in phases to reach Scripts/Notifi cation User.aspx?Id=10192 2% of the outstanding stock by March 2018. 24 See Frequently Asked Questions (FAQs): 29 See Trade Credit Policy — Rupee (INR) SEBI Foreign Portfolio Investors Regulations, Denominated trade credit // Reserve Bank of 2014 // Securities and Exchange Board of India. India. 2015. September 10. URL: http://www.rbi. URL: http://www.sebi.gov.in/cms/sebi_data/ org.in/Scripts/Notifi -cationUser.aspx?Id=10023 attachdocs/1467282054952.pdf 30 See External Commercial Borrowings 25 See Foreign Portfolio Investors Regulations (ECB) Policy — Issuance of Rupee denominated 70 // Securities and Exchange Board of India. 2014. bonds overseas // Reserve Bank of India. 2015. URL: http://www.sebi.gov.in/cms/sebi_data/ September 29. URL: http://www.rbi.org.in/Scripts/ attachdocs/1389083605384.pdf Notifi cationUser.aspx?Id=10049 INTERNATIONALIZATION OF THE RUPEE followed by a rationalization of the ECB son is a simple revenue loss argument. framework in November 201531 with IGIDR Finance Research Group (2016) the introduction of a unifi ed framework estimates that based on the trade volumes for rupee-denominated debt for Indian in these markets, Indian fi nancial fi rms are fi rms encompassing both onshore and potentially losing out on revenues worth off shore issuances, across a range of USD 500 billion annually. Th e second instruments including trade credit, loans argument is from the perspective of and bonds. Around one-fi ft h of Indian market regulators and effi cient exchange corporate fi nancing needs are met by rate management. Th e ineff ectiveness foreign currency borrowing. Almost all of a host of capital controls mounted by trade credit is denominated in foreign the RBI for its currency defence during currency. Permitting international the "taper tantrum" period of 2013 is banks and capital markets to raise rupee well-documented (Tayal, Rajat, 2013). debt marks a small but important step Denied access to the domestic markets, in solving the problem of "original sin" the participants shift ed to the off shore faced by fi rms and the government NDF markets which are subject to limited (Hausmann and Panizza, 2003). scrutiny by the domestic regulators. In this context, it is important to Th is had possible spillover eff ects on the highlight the role of hedging markets. domestic rates. Additionally, the RBI Th e presence of hedging markets allows had to resort to abandoning its monetary for internationalization of a currency as policy objectives in wake of the sharp both a vehicle for invoicing trade as well depreciation, raising domestic interest as fi nancial portfolio diversifi cation. In rates by 400 bps in a period of muted India’s case exchange traded currency growth. Lastly, fragmented markets derivatives were introduced in 2008 face more dispersed price discovery. but foreigners were not allowed to Divergence of rates in off shore NDF participate on exchanges till June 2014. markets and the onshore currency Th eir participation is also limited by markets can be frequently observed and detailed documentation requirements stresses the importance of a single market to show a demonstrable exposure along for effi cient price discovery (Hutchison et with restrictive margin requirements al., 2012). on exchanges. Th ere are position limits Dealing with off shore NDF mar- of USD 15 million on exchange traded kets has to be central to any policy derivatives and foreigners can only hedge deliberation for the development of up to their underlying exposure in the INR hedging markets. India can learn over the counter markets. Th is problem signifi cantly from the experience of is accentuated by restrictions on types of the China and Russia — two BRICS products, lack of overlap between Indian countries which have charted divergent trading hours and global trading times paths towards internationalization of and regulatory risk (Standing Council their currencies. Th e Russian ruble was on International Competitiveness of the made fully convertible in mid-2006. Indian Financial System, 2015). Subsequently, the off shore NDF markets Th e existence of such large NDF for ruble shift ed to onshore currency markets for the INR should be of concern markets. Currently, the ruble NDF has for domestic policymakers. Th e fi rst rea- the smallest share out of the BRICS currencies in the global NDF market. 31 Track III in the revised ECB framework, China on the other hand, has charted See External Commercial Borrowings (ECB) a completely diff erent route. Chinese Policy — Revised framework // Reserve Bank of 71 India. 2015. November 30. URL: http://www.rbi. authorities, while administrating strict org.in/Scripts/Notifi cationUser.aspx?Id=10153 capital controls, have permitted a pool USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

of off shore renminbi instruments that in partially convertible currencies and can be freely traded and delivered. Th e there are associated country risks in result has been a thriving market for dealing with banks from these countries off shore deliverable forwards which has in making bilateral currency markets33. eclipsed the renminbi NDF market. Th e Th is is unlikely to change soon given the leakiness of these capital controls were reversals in capital account liberalization exposed during the renminbi depreciation in the emerging world aft er the taper in August 2015. Th e volume of renminbi tantrum in 2013 (Gallagher, 2014). NDF trading almost quadrupled on Th e BRICS agenda needs to focus on August 11, 2015. Similar revivals were decentralized risk management at fi rm seen in the ruble NDF markets following level, both fi nancial and non-fi nancial, if events of political uncertainty and credit it wants to move towards LCY settlement constraints in Russia (McCauley and Shu, of trade amongst its member countries 2016). along with initiatives like the CRA. Increasing access to onshore hedging Th ere is no consensus in India about markets for foreigners and allowing access capital account convertibility and it to off shore markets to residents is an easy is diffi cult to judge whether India will fi rst step towards improving INR currency follow the Russian or the Chinese model risk management. Standing Council on of currency internationalization as there International Competitiveness of the have been proposals for both greater Indian Financial System (2015) off shore capital account convertibility34 and NDF markets. Improvement in INR risk fi nancial centers similar to Hong Kong35. management is likely to increase the Indian policymakers demonstrated a utilization of the INR as a trade currency. preference for a mix of both strategies, Th e government can continue its policy liberalization and setting up an eff orts in promoting use of the INR as international fi nancial center, but there trade invoicing currency, especially for has been very little synergy between both South-South trade and subsequently look eff orts36. at a gradual extension of off shore INR As of the writing of this paper the share settlement (deposits) and trade credit. of INR in global currency turnover is just Th e RBI however, is taking a calibrated 1% whereas India contributes almost approach32 to rupee internationalization 3% to global GDP. We anticipate a slow and does not mention any changes in internationalization of the INR, given local currency invoicing and settlement the current path of exchange control and for 2016–17; its policy focus is on capital account liberalization continues slowly improving hedging markets and until 2018. Given China’s experience with increasing use of INR as a currency for 33 See Iyer P.V. Why BRICS trade in local raising debt from foreign counterparties. currency doesn’t work for India // Th e Indian RBI’s reluctance to allow for LCY invoicing Express. 2015. July 13. URL: http://indianexpress. and settlement is understandable for two com/article/explai-ned/why-brics-trade-in-local- currency-doesnt-work-for-india-2/ reasons. First, India’s trade exposure to 34 See Committee on Fuller Capital Account nonconvertible currency trade partners Convertibility, 2006. is less than 10% excluding China and 35 See Setting up of IFSC Banking Units oil producing countries. Second, there (IBUs) // Reserve Bank of India. 2015. April 1. is a lack of risk management facilities URL: http://rbi.org.in/Scripts/Notifi cationUser. aspx?Id=9636 (for notifi ed legal framework). 32 See Annual Report. Financial Markets 36 See Nair A. RBI Governor suggests single and Foreign Exchange Management // Reserve regulator for GIFT City // Th e Indian Express. 72 Bank of India. 2016. August 29. URL: http://www. 2017. January 12. URL: http://indianexpress.com/ rbi.org.in/scripts/AnnualReportPublications. article/business/business-others/rbi-governor- aspx?Id=1178 suggests-single-regulator-for-gift -city/ INTERNATIONALIZATION OF THE RUPEE

Hong Kong, an international fi nancial future in Asia and the Pacifi c // BIS. center in Gandhinagar is likely accelerate BIS Papers. 2011. No. 61. P. 105–124. the process of INR internationalization URL: http://www.bis.org/publ/bppdf/ and fi nancial sector reform. Th e RBI bispap61.pdf will continue to remain cautious and is 6. Goldberg L. S., Tille C. Vehicle unlikely to shift from its "wait and watch" currency use in international trade // approach before committing to the Journal of international Economics. 2008. next phase of INR internationalization No. 76(2). P. 177–192. reforms. We do not expect any "big 7. Hausmann R., Panizza U. On the bang" changes before the next policy determinants of Original Sin: an empirical cycle begins in 2020. Given recent investigation // Journal of International changes in regulatory frameworks, we Money and Finance. 2003. No. 22(7). also anticipate a clear medium to long P. 957–990. term plan articulated by the RBI in 8. Hutchison M. M., Pasricha G. K., conjunction the Ministry of Finance, if Singh N. Eff ectiveness of capital controls and when they decide to pursue rupee in India: Evidence from the off shore NDF internationalization. market // IMF Economic Review. 2012. No. 60 (3). P. 395–438. References 9. Ito H., Chinn M. Th e Rise of the “Redback” and the People’s Republic of 1. Dixon C. Th e New BRICS Bank: China’s Capital Account Liberalization: Challenging the International Financial An Empirical Analysis of the Deter- Order? // Th e Global Policy Institute. minants of Invoicing Currencies // London Metropolitan University. 2015. Asian Development Bank Institute. No. 28. URL: http://www.gpilondon. Working Paper. 2014. No. 473. URL: com/wp-content/uploads/PP28-The- http://www.adb.org/sites/default/files/ New-BRICS-Bank.pdf publication/156328/adbi-wp473.pdf 2. Features and trends of NDF markets 10. Ito T. A New Financial Order for Emerging Economy Currencies: in Asia: Will a RMB bloc emerge? // A study of the Indian Rupee // IGIDR National Bureau of Economic Research. Finance Research Group. 2016. March. Working Paper. 2016. No. 22755. URL: URL: http://www.ifrogs.org/POLICY/ http://www.nber.org/papers/w22755.pdf ndfReport.html 11. Langedijk S., Karagiannis S., 3. Fernandez A., et al. Capital Control Evangelia P. Invoicing Currencies in Measures: A New Dataset / A. Fernandez, Interna-tional Trade — Drivers and M. W. Klein, A. Rebucci, M. Schindler, Obstacles to the Use of the Euro // Joint M. Uribe // National Bureau of Economic Research Centre. Scientifi c and Technical Research. Working Paper. 2015. Research Report. 2016. URL: http:// No. 20970. URL: http://www.nber.org/ publications.jrc.ec.europa.eu/repository/ papers/w20970.pdf bitstream/JRC96913/lbna27754enn.pdf 4. Gallagher K. P. Ruling capital: Emer- 12. Ma G., McCauley R. N. Is China or ging markets and the reregulation of India more fi nancially open? // Journal of cross-border fi nance. Cornell University International Money and Finance. 2013. Press, 2014. No. 39. P. 6–27. 5. Gao H., Yu Y. Internationalization 13. Ma G., Villar A. Internationalisation of the renminbi // Currency interna- of emerging market currencies // Th e tionalisation: lessons from the global transmission of unconventional monetary 73 fi nancial crisis and prospects for the policy to the emerging markets // BIS. USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

BIS Papers. 2014. No. 78. P. 71–87. nic.in/reports/Standing%20Council%20 URL: http://www.bis.org/publ/bppdf/ Report%20IFS.pdf bispap78.pdf 22. Sengupta R. Th e impossible trinity: 14. Masala Bond List // London Stock Where does India stand? // International Exchange. 2016. URL: http://www.lseg. Trade and International Finance / M. Roy, com/masala S. Sinha Roy (eds.). Springer India, 2016. 15. McCauley R. N., Shu C. Non-deli- P. 511–523. verable forwards: impact of currency 23. Shu C., He D., Cheng X. One internationalisation and derivatives currency, two markets: the renminbi’s reform // BIS. BIS Quarterly Review. growing infl uence in Asia-Pacifi c // BIS. 2016. December. URL: http://www.bis. Working Paper. 2014. No. 446. URL: org/publ/qtrpdf/r_qt1612h.pdf http://www.bis.org/publ/work446.pdf 16. Moore M., Schrimpf A., Sushko V. 24. Survey on the holdings of cur- rencies in offi cial foreign currency assets // Downsized FX markets: causes and IMF. 2015. URL: http://www.imf.org/~/ implications // BIS. BIS Quarterly Review. media/Images/IMF/Data/080415.ashx 2016. December. URL: http://www.bis. org/publ/qtrpdf/r_qt1612e.pdf 25. Tayal R. Impact of restrictions on currency derivatives on market quality 17. Patnaik I., Shah A. Did the Indian // IGIDR Finance Research Group. Capital Controls Work as a Tool of 2013. October. URL: http://ifrogs.org/ Macroeconomic Policy&quest? // IMF PDF/201309_restrictionsOnCurrencyDe Economic Review. 2012. No. 60(3). rivatives.pdf P. 439–464. 26. Triennial Central Bank Survey. 18. Ranjan R., Prakash A. Interna- Foreign exchange and derivatives market tionalization of Currency: Th e case of the activity in April 2010. Preliminary results Indian Rupee and Chinese Renminbi // // BIS. 2010. URL: http://www.bis.org/ Reserve Bank of India Report. RBI Staff publ/rpfx10.pdf Studies. 2010. No. 3. URL: http://rbidocs. 27. Triennial Central Bank Survey of rbi.org.in/rdocs/PublicationReport/Pdfs/ foreign exchange and derivatives market RRSS180510F.pdf activity in 2013 // BIS. 2013. URL: http:// 19. Renminbi internationalization: www.bis.org/publ/rpfx13.htm Achievements, prospects and challenges / 28. Triennial Central Bank Survey of B. J. Eichengreen, M. Kawai (eds.) // foreign exchange and OTC derivatives Asian Development Bank Institute. markets in 2016 // BIS. 2016. URL: http:// Brookings Institution. Tokyo, 2015. www.bis.org/publ/rpfx16.htm URL: http://www.adb.org/sites/default/ fi les/publication/159835/adbi-renminbi- internationalization-achievements- prospects-challenges.pdf 20. Report of the Committee on Fuller Capital Account Convertibility // Reserve Bank of India. 2006. July 31. URL: http://rbidocs.rbi.org.in/rdocs/ PublicationReport/Pdfs/72250.pdf 21. Report of the Standing Council on International Competitiveness of the 74 Indian Financial Sector // Ministry of Finance. 2015. Vol. 1. URL: http://fi nmin. INTERNATIONALIZATION OF THE RUPEE

Appendix

List of countries Country Code Country IN India BR Brazil CN China RU Russia KR South Korea PE Peru CZ Czech Republic HU Hungary CL Chile ID Indonesia TH Th ailand MY Malaysia CO Colombia MX Mexico TR Turkey ZA South Africa PL Poland PH Philippines

75 USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Chapter 5

The Internationalization of RMB: China’s Experience1

Th e Chinese government has be- pilot program on RMB settlement in gun to gradually promote RMB inter- cross-border trade", extending the pi- nationalization since the GFC. Th e pressing lot regions from Shanghai and four need for the reform of the international cities of Guangdong to more than 20 monetary system, the steady growth of provinces and municipalities including the Chinese economy, the government’s Beijing, Tianjin, Jiangsu, Zhejiang support and the RMB appreciation and Fujian. Th en, in August 2011, the expectation over the past several years six government departments jointly have worked together to propel RMB issued "Notice on enlarging regions internationalization. In October 2016, for RMB settlement in cross-border RMB was offi cially included into the trade", extending the pilot regions to SDR currency basket by the International the whole country. It is noteworthy that, Monetary Fund, highlighting global instead of putting forward the idea of recognition of the achievements of RMB RMB internationalization, the aim for internationalization over the past years. the central government to advance this Between 2009 and 2016, RMB pilot program at that time was to help internationalization made remarkable enterprises avoid exchange rate risk progress. In summary, the achievements and reduce exchange loss. It showed include following aspects. that, during that period, the Chinese government was very cautious about Encouraging RMB internationalization. For the purpose of further expanding enterprises to use the use of RMB in cross-border trade RMB settlement in and investment and regulating the cross-border trade and banks and overseas investors in carrying investment out settlement for RMB-denominated foreign direct investment, the People’s Pilot program on RMB settlement Bank of China had formulated in trade in goods started in December "Administrative Rules on Settlement 2008. In June 2010, People’s Bank of of RMB-denominated Foreign Direct China, Ministry of Finance, Ministry Investment" on October 14, 2011.Th is of Commerce, General Administration means that overseas investors and the of Customs, State Administration of banks can carry out settlement for RMB- Taxation and China Banking Regulatory denominated foreign direct investment Commission jointly issued "Notice on according to the new administrative issues concerning the expansion of rules, eff ectively expanding the cross- border use of RMB and substantially 1 Liu Dongmin, Xiao Lisheng, Lu Ting, facilitating trade and investment 76 Xiong Aizong, Zhang Chi — Institute of World Economics and Politics, Chinese Academy of while advancing the progress of RMB Social Sciences. internationalization. On June 14, 2012, THE INTERNATIONALIZATION OF RMB: CHINA’S EXPERIENCE

3, 000

2, 000

1, 000

0 2011-03 2011-06 2011-09 2011-12 2012-03 2012-06 2012-09 2012-12 2013-03 2013-06 2013-09 2013-12 2014-03 2014-06 2014-09 2014-12 2015-03 2015-06 2015-09 2015-12 2016-03 RMB settlement in cross-border trade: actual payments RMB settlement in cross-border trade: actual receipts Figure 1. Cross-border fl ow of RMB fund, bn yuan Source: Wind Database for the purpose of implementing "Administrative Rules on Pilot Program "Administrative Rules on Settlement of RMB Settlement of Cross-border of RMB-denominated Foreign Direct Trade Transactions", the People’s Bank Investment", facilitating RMB-deno- of China and the State Administration minated foreign direct investment of Foreign Exchange had issued in by overseas investors and regulating July 2009 respectively "Regulations for the banks and fi nancial institutions Implementing the Administrative Rules in carrying out settlement for RMB- on Pilot Program of RMB Settlement of denominated foreign direct investment, Cross-border Trade Transactions" and the People’s Bank of China issued "Notice on related issues concerning the "Notice on Specifying Operating Rules on declaration and statistics on international Settlement of RMB-denominated Foreign receipts and payments in RMB settlement Direct Investment". of cross-border trade transactions", so as In addition, the People’s Bank of China to facilitate implementation and progress also made joint eff orts with other related of the use of RMB in cross-border departments to adopt a series of supportive settlement. measures to facilitate the use RMB in RMB cross-border settlement has cross-border settlement. On July 1, 2009, been accelerating as China’s international the People’s Bank of China, Ministry of trade and direct investment keep growing. Finance, Ministry of Commerce, General Currently, RMB cross-border settlement Administration of Customs, State Admi- has been expanded to all regions in the nistration of Taxation and China Banking country, with no geographic restrictions in Regulatory Commission jointly issued overseas markets. According to statistics "Administrative Rules for the Pilot from People’s Bank of China, RMB cross- Program on RMB Settlement of Cross- border settlement has covered more than Border Trade" to regulate the behaviors 210 foreign countries and regions. of pilot enterprises and commercial RMB cross-border settlement under banks and prevent related business current account has developed rapidly risks so as to promote trade facilitation (Figure 1). and ensure smooth implementation of Th e absolute size of RMB settlement the pilot program on RMB settlement in cross-border trade has soared from 3.6 77 in cross-border trade. To implement billion yuan in the fi rst quarter of 2009 USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

to 1.3 trillion yuan in the third quarter of had begun to decline while the actual 2016. Due to impact of the European debt payments had fl uctuated. crisis, the growth of RMB settlement in Th e aggregate amount of RMB cross-border trade had stopped between settlement in cross-border trade has reached 6.47 trillion yuan in the fi rst the second half of 2011 and early 2012 ten months of 2016 among which trade but rebounded rapidly between 2012 and in goods, standing at 3.46 trillion yuan, 2013. In March, 2014, aft er the daily range accounted for 54% of the total; foreign of RMB exchange rate fl uctuation was direct investment, 1.15 trillion yuan, enlarged from 1% to 2%, the size of RMB 18%; trade in service and other current settlement in cross-border trade began to accounts, 931.6 billion yuan, 14%; fl uctuate vehemently. Since the "August outbound direct investment, 921.1 billion yuan, 14% (Figure 2). 11" foreign exchange rate reform in 2015, To support implementation of RMB the growth of RMB settlement in cross- cross-border settlement, China’s banks border trade has decelerated signifi cantly. have set up RMB clearing mechanism As a key base of intermediary trade for in 21 countries and regions by the end domestic enterprises to take part in the of September, 2016, covering Southeast global trade, Hong Kong has played a Asia, West Europe, Middle East, North major role in RMB settlement in cross- Аmerica, South America and Oceania. border trade. Between the fourth quarter of 2009 and the fi rst quarter of 2015, about Currency swap 80% of RMB settlements in cross-border and direct currency trade are done through Hong Kong. trading with RMB In terms of capital account, the Th e purpose for People’s Bank of amount of actual receipts and payments China to sign currency swap agreements had both increased year by year before the with overseas monetary authorities is "August 11" foreign exchange rate reform not only to maintain regional fi nancial in 2015. Aft er that, the actual receipts of stability but, more importantly, to RMB settlement in cross-border trade facilitate development of bilateral trade

18 Trade in goods

Trade in services 14 54 and other current account

Outbound direct investment 14 Foreign direct investment

78 Figure 2. Cross-border fl ow of RMB settlement in the fi rst 10 months of 2016, % Source: People’s Bank of China THE INTERNATIONALIZATION OF RMB: CHINA’S EXPERIENCE and investment. Th e amount of money for the third party currency and reduce the currency swap can be used to support local exchange cost of transaction to facilitate enterprises’ trade and investment so as to bilateral trade, investment and fi nancial promote use of the two sides’ currencies cooperation. in bilateral trade and investment, which Direct currency trading has been will help not only lower the exchange developed between RMB and 21 non-US risk that the fl uctuation of the dollar will dollar currencies. Since the establishment cause in the bilateral international eco- of the Bretton Woods system, the US nomic activities between both sides of dollar has played a central role in the currency swap but also reduce exchange international monetary system as the cost to boost bilateral trade and most important global currency for trade, investment. investment and reserve. Th erefore, in the Since the GFC, China has kept pro- beginning, direct currency trading was moting currency cooperation and signing developed only between RMB and the and renewing bilateral currency swap US dollar on the back of which indirect agreements with overseas central banks currency trade had then been developed or monetary authorities. China has so far between RMB and other currencies. signed bilateral currency swap agreements However, the use of US dollar as the with central banks or monetary autho- medium of exchange both adds to the rities from 36 countries and regions cost and inconvenience of currency including Hong Kong, Malaysia, Belarus, trading between RMB and other foreign Indonesia and South Korea. By the currencies and increases the exchange end of 2016, the amount of money that risk for both sides. Th erefore, as RMB those currency swap agreements actually internationalization presses ahead and involved has exceeded 3.1 trillion yuan foreign economic and trade relations keep (Table 1). growing, it is urgent to establish a direct In terms of the currency swap currency trading mechanism between agreements that are currently eff ective, RMB and other currencies. Hence, since most countries and regions that have 2010 China Foreign Exchange Trade signed currency swap agreements with System has fi rst opened direct currency People’s Bank of China come from Asia trading between RMB and Malaysian and Pacifi c area. But in recent years, the ringgit and then developed direct number of such countries from Europe, currency trading between RMB and Africa and Latin America also increased 21 non-US dollar currencies including gradually. China has signed currency Russian rubble, Japanese yen, Australian swap agreements with other BRICS dollar, New Zealand dollar, pound, euro, countries such as Brazil (expired), Russia Singapore dollar, Swiss franc, South and South Africa, creating favorable African rand, Korean won, UAE dirham, conditions for further promotion of use Saudi riyal, Canada dollar (Table 2). of their own currencies among BRICS countries. Direct currency trading between RMB Construction and foreign currencies represents another of off-shore RMB major step forward during the course financial centers of RMB internationalization that helps increasing RMB settlement in bilateral Construction of off shore RMB mar- trade and investment and raises the kets is proceeding apace. Off shore RMB international status of RMB. Meanwhile, markets develop rapidly. Hong Kong direct currency trading with RMB can has become the most important RMB 79 avoid the cost of denominating with off shore center in the world and RMB USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Table 1 Bilateral local currency swap agreements signed between People’s Bank of China and other central banks or monetary authorities Th e other Signing time Swap size Term party of Swap 2009.1.20 200 bn yuan/ 227 bn HK dollar 3 yrs Hong Kong 2011.11.22 (renewed) 400 bn yuan/490 bn HK dollar (renewed) 2014.11.22 (renewed) 400 bn yuan / 505 bn HK dollar (renewed) 2009.2.8 80 bn yuan / 40 bn Malaysian ringgit 3 yrs 2012.2.8 (renewed) 180 bn yuan/ 90 bn Malaysian ringgit 3 yrs Malaysia (renewed) 2015.4.17 (renewed) 180 bn yuan / 90 bn Malaysian ringgit (renewed) 2009.3.11 20 bn yuan / 8 trn Belarusian ruble 3 yrs Belarus 2015.5.10 (renewed) 7 bn yuan /16 trn Belarusian ruble (renewed) 2009.3.23 100 bn yuan/ 175 trn Indonesian rupiah 3 yrs Indonesia 2013.10.1 (renewed) 100 bn yuan/175 trn Indonesian rupiah (renewed) 2009.4.2 70 bn yuan/38 bn Argentine peso 3 yrs Argentina 2014.7.18 (renewed) 70 bn yuan / 90 bn Argentine peso (renewed) 2009.4.20 180 bn yuan / 38 trn South Korean won 3 yrs 2011.10.26 (renewed) 360 bn yuan/64 trn South Korean won South Korea (renewed) 2014.10.11 (renewed) 360 bn yuan / 64 trn South Korean won (renewed) 2010.6.9 3.5 bn yuan/66 bn Icelandic krona 3 yrs Iceland 2013.9.11 (renewed） 3.5 bn yuan / 66 bn Icelandic krona (renewed) 2010.7.23 150 bn yuan/30 Singapore dollar 3 yrs 2013.3.7 (renewed) 300 bn yuan / 60 bn Singapore dollar Singapore (renewed) 2016.3.7 (renewed) 300 bn yuan/60 bn Singapore dollar (renewed) 2011.4.18 25 bn yuan/5 bn New Zealand dollar 3 yrs New Zealand 2014.4.25 (renewed) 25 bn yuan/5 bn New Zealand dollar (renewed) Uzbekistan 2011.4.19 0.7 bn yuan / 167 bn Uzbekistan som 3 yrs (expired) 2011.5.6 5 bn yuan/1 trn Mongolian tugrik 3 yrs 2012.3.20 (supplemental) 10 bn yuan / 2 trn Mongolian tugrik Mongolia (expanded) 2014.8.21 (renewed) 15 bn yuan/4.5 trn Mongolian tugrik (renewed) 2011.6.13 7 bn yuan/150 bn Kazakhstani Tenge 3 yrs Kazakhstan 2014.12.14 (renewed) 7 bn yuan/200 bn Kazakhstani Tenge (renewed) 80 2011.12.22 70 bn yuan/320 bn Th ailand baht 3 yrs Th ailand 2014.12.22 (renewed) 70 bn yuan/370 bn Th ailand baht (renewed) THE INTERNATIONALIZATION OF RMB: CHINA’S EXPERIENCE

Table 1 (Th e completion) 2011.12.23 10 bn yuan/140 bn Pakistani rupee 3 yrs Pakistan 2014.12.23 (renewed) 10 bn yuan/165 bn Pakistani rupee (renewed) 2012.1.17 35 bn yuan/20 bn UAE dirham 3 yrs UAE 2015.12.14 (renewed) 35 bn yuan/20 bn UAE dirham (renewed) 2012.2.21 10 bn yuan/3 bn Turkish lira 3 yrs Turkey 2015.9.26 (renewed) 12 bn yuan/5 bn Turkish lira (renewed) 2012.3.22 200 bn yuan/30 bn Australian dollar 3 yrs Australia 2015.3.30 (renewed) 200 bn yuan/40 bn Australian dollar (renewed) 2012.6.26 15 bn yuan/19 bn Ukrainian hryvna 3 yrs Ukraine 2015.5.15 (renewed) 15 bn yuan / 54 bn Ukrainian hryvna (renewed) Brazil 2013.3.26 190 bn yuan/60 bn Brazilian real 3 yrs (expired) 2013.6.22 200 bn yuan/20 bn GB pound 3 yrs UK 2015.10.20 (renewed) 350 bn yuan/35 bn GB pound (renewed) Source: People’s Bank of China

Table 2 Direct trading between China and non-US-dollar currencies Time Direct trading currency Time Direct trading currency 2010.8.19 Ringgit (Malaysia) 2016.9.23 Dihram (UAE) 2010.11.22 Ruble (Russia) 2016.9.23 Riyal (Saudi Arabia) 2012.5.29 Yen (Japan) 2016.11.11 Canada dollar (Canada) 2013.4.9 Australian dollar (Australia) 2016.12.9 Swedish krona (Sweden) New Zealand dollar (New 2014.3.18 2016.12.9 Norwegian krone (Norway) Zealand) 2014.6.18 GB pound (UK) 2016.12.9 Turkish lira (Turkey) 2014.9.29 Euro (Euro zone) 2016.12.9 Mexican peso (Mexico) 2014.10.27 Singapore dollar (Singapore) 2016.12.9 Hungarian forint (Hungary) 2015.11.9 Swiss franc (Switzerland) 2016.12.9 Danish krone (Denmark) 2016.6.17 Rand (South Africa) 2016.12.9 Polish zloty (Poland) 2016.6.24 Won (South Korea) Source: China Foreign Exchange Trade System business is booming in Singapore, in Hong Kong had increased from less Taipei, London, Luxembourg, Paris and than 100 billion yuan in July 2010 to Frankfurt. RMB clearing banks can be 662.5 billion yuan in October 2016. Th is found in major fi nancial trading market is a result of the cooperation between in Asia, Europe, America, Africa and People’s Bank of China and Hong Kong Oceania. In October 2015, People Bank Monetary Authority to substantially of China set up CIPS, a key infrastructure expand the scope for RMB business for RMB internationalization, to facilitate in Hong Kong by adopting a series of RMB cross-border and off shore business supportive policies. However, like RMB for domestic and foreign fi nancial settlement in cross-border trade, the 81 institutions. Th e amount of RMB deposits growth of RMB deposits in Hong Kong USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

200 180 160 140 120 100 80 60 40 20 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Figure 3. Issuance of Dim Sum bonds, bn yuan Source: Wind Database (by December 5, 2016)

had once turned negative between the among which RFDI and RQFII are second half of 2011 and early 2012. Aft er the main channels for inward fl ow of the "August 11" foreign exchange reform overseas RMB under capital account. in 2015, RMB deposits in Hong Kong In the third quarter of 2016, China’s witnessed massive negative growth. It is RMB settlement in cross-border direct noteworthy that among RMB deposits investment amounted to 1.8 trillion yuan in Hong Kong, the proportion of term among which RODI and RFDI accoun- deposits climbed from 30% in 2009 to ted for 830 billion and 1.004 trillion about 83% in 2016, indicating that RMB yuan respectively. By now, the Chinese deposits in Hong Kong originate from the mainland has approved an aggregate outfl ow of fund from cross-border trade RQFII quota of 329.8 billion yuan for 6 settlement and have inadequate fi nancial countries and regions. China Securities investment instruments. Regulatory Commission will further RMB cross-border business under deepen reform of the RQFII mechanism capital account has been making break- to break the quota limit of 1 billion dollar throughs. Th ere are more and more and facilitate inward and outward fl ow channels for inward RMB cross-border of capital. fl ow including RMB Qualifi ed Foreign Fundamentally speaking, to achieve Institutional Investor, RMB foreign full RMB internationalization, China direct investment, the entry of three types must realize fi nancial liberalization and of foreign institutions into the interbank full convertibility of capital account. But bond market, RMB cross-border the reform of fi nancial liberalization must loans and Shanghai-Hong Kong Stock be carried out step by step. To promote Connect. Channels for outward RMB RMB internationalization under the cross-border fl ow under capital account condition of incomplete convertibility mainly include RMB Qualifi ed Domestic of capital account, it is very important to 82 Institutional Investor, RMB Overseas develop off shore RMB fi nancial markets Direct Investment and enterprises’ RMB because such off shore markets are needed loans to overseas subsidiary companies to provide non-residents holding RMB THE INTERNATIONALIZATION OF RMB: CHINA’S EXPERIENCE a platform for RMB-denominated trade, driving force behind the fl uctuation of investment and settlement. And off shore the Dim Sum issuance volume (Figure 3). markets should be properly separated Dim Sum bonds issued in Hong Kong from onshore markets. By now, RMB face three key challenges. Th e fi rst is lack off shore fi nancial centers have been set of liquidity and a secondary market. up in Hong Kong, Taiwan, Singapore, Because of its limited market size, Dim London, Frankfurt, Paris, Luxembourg Sum bond market is short of market- makers. According to data from the and Toronto to provide RMB investment bond quotation website of the Central products in off shore markets through Money markets Unit with the Hong Dim Sum bonds, RQFII, cross-border Kong Monetary Authority, all RMB- loans, Shanghai-Hong Kong Stock denominated bonds are not actively Connect program and Shenzhen-Hong traded except the national bonds issued Kong Stock Connect program. During by China’s Ministry of Finance, which is this process, China expands convertibility traded in the OTC market. of capital account in an orderly and Th e second challenge is lack of bond prudential approach. ratings and short maturity, and investors usually prefer to hold short-term bonds. A. Dim Sum bonds Under these circumstances, off shore Dim Sum bonds refer to off shore RMB-denominated bonds do not have bonds issued in Hong Kong by domestic a yield curve of RMB for reference and Hong Kong fi nancial market cannot fi nancial institutions and enterprises. provide RMB bonds with high liquidity China Development Bank issued the fi rst and reasonable duration structure. off shore RMB bond in Hong Kong in June Th e third is that bond issuance is 2007, ushering in a new chapter in the aff ected by the exchange rate of RMB. development of Dim Sum bond market. As long as the current devaluation Aft er the initial phase of development, expectation exists, investors’ enthusiasm Dim Sum bond market witnessed a can hardly return. Inclusion of RMB into period of explosive growth between 2010 SDR and gradually more convertibility and 2014. In 2014, issuance of Dim Sum under capital account will add to the bonds in Hong Kong totaled 183.1 billion diffi culties of keeping exchange rate yuan, up 89% year-on-year, of which 90% stable and thus Dim Sum bond market were fi nancial bond and corporate bond might shrink further. and more than 75% 1–3 year short-term bonds. B. RQFII Aft er years of stable growth, Dim Sum RQFII refers to RMB Qualifi ed bonds face new challenges against the Foreign Institutional Investors. Th rough pressure of RMB devaluation. Issuance RQFII mechanism, overseas institutions of Dim Sum bonds plummeted between can make use of RMB fund raised in off shore markets to invest in China’s 2015 and 2016. Th e total Dim Sum domestic capital market. On August issuance volume was 91.7 billion yuan 17, 2011, then Vice Premier Li Keqiang in 2015, roughly half of that in 2014. It said at a forum in Hong Kong that RMB declined further in 2016. By December 5, Qualifi ed Foreign Institutional Investors the total Dim Sum issuance volume has will be allowed to invest in the domestic reached only 32.7 billion yuan in 2016, securities market with a starting quota of basically as much as that in 2010. Th is fact 20 billion yuan (Figure 4). shows that changing expectation on the Since then, qualifi ed foreign insti- 83 foreign exchange rate of RMB is the major tutional investors have gradually acce- USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

600

500

400

300

200

100

0 2011-12 2012-03 2012-06 2012-09 2012-12 2013-03 2013-06 2013-09 2013-12 2014-03 2014-06 2014-09 2014-12 2015-03 2015-06 2015-09 2015-12 2016-03 2016-06 2016-09 Figure 4. RQFII investment, bn yuan Source: Wind Database

lerated their participation in the dome- explanations. One is that Hong Kong stic securities market under RQFII funds tend to allocate most of their mechanism. In recent years, as RMB assets in Asia Pacifi c areas and have high internationalization moves ahead and demand for domestic RQFII while funds restrictions on asset allocation are from UK, France and Germany prefer to gradually removed, investment through global asset allocation and have relatively RQFII has increased steadily. RQFII few demand for the domestic stock invested 4,599.2 billion yuan in 2015, on market. Th e other is that investors from average 383.2 billion yuan per month, other regions can hardly understand while having opened 942 accounts in Chi- complex regulatory measures over na’s A-share market by the end of 2015. RQFII. According to the approval process In 2016, RQFII basically continued the of RQFII, China Securities Regulatory momentum of steady growth of the Commission is responsible for approving previous year, investing 4,947.9 billion the qualifi cation of RQFII and the State yuan in the fi rst ten months and having Administration of Foreign Exchange will opened 1,067 accounts in the A-share approve the total quota for a certain region market by the end of October. and specifi c quota for each fi nancial During the two-day China-US Strate- gic and Economic Dialogue in June 2016, institution. For overseas investors, each Yi Gang, deputy governor of People’s RQFII business will face restrictions Bank of China, indicated that China over institutional qualifi cation, approval would provide the US with RQFII quota of quota and structure of products. of 250 billion yuan (USD 38 billion). Th is Since Hong Kong banks and investors is the fi rst time that China has provided have done more businesses related to the US with such a quota, a milestone the domestic market, they are able to for RMB internationalization and RQFII interpret such regulations in a more mechanism. fl exible way. If the RQFII mechanism is Research shows that most quota of to be further expanded, it is necessary 84 RQFII are used by institutional investors to further streamline its regulatory and from Hong Kong. Th ere are mainly two approval system. THE INTERNATIONALIZATION OF RMB: CHINA’S EXPERIENCE

C. Cross-border RMB Loans of Comprehensive Financial Reform and Cross-border RMB loans is one of the Fujian (Pilot) Free Trade Zone. measures that the Chinese government In December 2014, Qianhai Financial Holdings and 6 fi nancial institutions from has taken to enable overseas fi nancial Shenzhen and Hong Kong arranged the institutions to channel overseas RMB fi rst cross-border RMB syndicated loan in back into the domestic market, ensuring Qianhai, marking the debut and pricing use of RMB as a settlement currency to of "Qianhai Concept" and cross-border meet real trade and investment demand. RMB syndicated loan in Hong Kong In January 2013, Qianhai has become interbank market, another milestone the fi rst region in China to provide in cross-border RMB loans. Now, cross-border RMB loans, marking a new enterprises in Qianhai can not only raise milestone in RMB internationalization. funds from Hong Kong banks through With construction of Qianhai being overseas loans under domestic guarantee accelerated, the scope and procedure and direct loans but also obtain cross- of RMB settlement in cross-border border fi nancing through syndicated trade has been gradually expanded loans. Th e arrangement of cross-border and optimized and the size of cross- fi nancing can signifi cantly cut loan border RMB loans has grown rapidly interest rates for enterprises. RMB loans in Qianhai. By the end of March, 2015, that enterprises obtained from overseas the registered volume of cross-border fi nancial institutions are priced according to market interest rates in Hong Kong the RMB loans in Qianhai had reached 91.1 level of which is about 10% below the billion yuan with 22.8 billion yuan having benchmark interest rates set by the central been withdrawn. Th e two fi gures in 2013 bank in the domestic market. And such were 14.8 billion yuan and 3.36 billion loans have opened a channel of overseas yuan respectively. By now, more than fi nancing for enterprises, especially large 30 central SOEs and industrial leaders enterprises. including China Everbright Internatio- In comparison with registered volume, nal, China General Nuclear Power the actual amount of loans that have been Group, China Resources (Holdings), withdrawn are yet to be increased. In fact, China Shipbuilding Industry Company, as overseas RMB interest rates climb, the the S.F Express Company, Industrial cost of cross-border RMB fi nancing has Bank Financial Leasing Company, Chi- also risen to shrink the price advantage of na Poly Group, China Gezhouba cross-border RMB loans. Group, HSAE, Guangxi Nonferrous In addition, the target clients of cross- Metals Group, Shenzhen MTC, Shen- border loans in Qianhai are enterprises zhen Tianyuan Dic Information Tech- registered in Qianhai most of which are nology Company, Longgang City Inves- newly set up and have only limited size and credit. Hong Kong banks usually can tment&Development, Baoan Con- provide loans to them only with guarantee struction Investment Group, and China from domestic banks. Hence, it is more Aerospace Science and Industry Corp than oft en that only enterprises with high have entered Qianhai to engage in cross- qualifi cations can obtain loans while border loan business for the support small and medium-sized enterprises have of low-cost capital. Based on the pilot little access to low-cost loans. In principle, program of cross-border RMB loans in it takes only two work weeks to get loans Qianhai, the Chinese government has registered and granted. But the actual since extended such pilot programs to procedure for enterprises to withdraw 85 Xiamen, Quanzhou Experimental Area loans is much more time-consuming. USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

250 Trade volume of Hong Kong stock connect Trade volume of Shanghai stock connect 200

150

100

50

0 2015-03 2015-05 2014-11 2015-01 2015-07 2015-09 2015-11 2016-01 2016-03 2016-05 2016-07 2016-09 2016-11 Figure 5. Trade volume of Shanghai-Hong Kong Stock Connect, bn yuan Source: Wind Database

Th at Hong Kong banks have strict balance of each individual investor requirements over the usage, cost and participating the program should be no term of loans also, to a certain extent, less than 500,000 yuan. adds to the cost of guarantee and thus Shanghai-Hong Kong Stock Connect the cost of loans for enterprises. Besides program includes two parts: the part of the price factor, business insiders pointed Shanghai stock connect refers to that out that another reason why the amount investors can trade designated shares of funds withdrawn from cross-border listed on Shanghai Stock Exchange by loans in Qianhai is limited is the sources using Hong Kong dealers and the stock of capital are relatively monotonic — trading service company set up by the they are provided only by banks in Hong Stock Exchange of Hong Kong; the part Kong. of Hong Kong stock connect refers to that investors can trade designated shares D. Shanghai-Hong Kong listed on the Stock Exchange of Hong Stock Connect Kong by using domestic securities fi rms Shanghai-Hong Kong Stock Connect and the stock trading service company set program refers to the scheme that up by Shanghai Stock Exchange. Shanghai Stock Exchange and the Stock As a major innovation of the two-way Exchange of Hong Kong permit investors opening-up of China’s capital market, from both sides to trade designated "Shanghai-Hong Kong Stock Connect" shares on the other market using their has achieved maximum market eff ect local clearing houses (or brokers). It is an with minimum institutional cost. Th e investment channel that connects stock design of the principle of locality and markets in Shanghai and Hong Kong. On close-ended settlement in the program April 10, 2014, China Securities Regulatory has allowed investors from both sides to Commission offi cially approved the invest in the other market while using, pilot stock connect program. Th e CSRC to the maximum extent, laws, rules and noted that the total quota for Shanghai- trade habits in their own market. Th is 86 Hong Kong Stock Connect program is marks the fi rst step of two-way opening- 550 billion yuan and the capital account up of China’s capital market under the THE INTERNATIONALIZATION OF RMB: CHINA’S EXPERIENCE condition of regulatory transparency and 95 from Hong Seng Composite Smallcap rick control (Figure 5). Index and 29 A+H shares beyond these By November 2016, Shanghai-Hong indexes. Th ese shares accounted for 87% Kong Stock Connect has had an aggregate of the total market valuation of the Stock trade volume of 3,565.751 billion yuan Exchange of Hong Kong and 91% of the among which Hong Kong stock connect average daily trade volume. On the same contributed 1,263.908 billion yuan and day, the Stock Exchange of Hong Kong Shanghai stock connect 2,301.843 billion announced 881 shares under Shenzhen- yuan. A review of the achievement Hong Kong Stock Connect program of "Shanghai-Hong Kong Stock Connect" including 267 from the Main Board of shows that, though the overall trade Shenzhen Stock Exchange, 411 from the volume is not as large as expected, the Small and Medium Enterprise Board and program has operated smoothly, standing 203 from the Growth Enterprise Board, the test of the volatile fl uctuation in altogether accounting for 71% of the total the A-share market while providing market valuation of Shenzhen’s A-Share a replicable sample for other programs market and 66% of the average daily trade such as Shenzhen-Hong Kong Stock volume. Connect and Shanghai-London Stock Till the end of October 2016, more Connect. than 1,860 companies have been listed in Shenzhen Stock Exchange with a total E. Shenzhen-Hong Kong market valuation of about 23 trillion yuan. By now, the trade volume has Stock Connect reached 64 trillion yuan, ranking high Shenzhen-Hong Kong Stock Connect among all stock exchanges around the refers to the technology connect built world. And the collective characteristic between Shenzhen Stock Exchange and of listed companies in Shenzhen Stock the Stock Exchange of Hong Kong that Exchange is innovation and growth. enable domestic and Hong Kong investors In retrospect, on the opening day of to trade designated shares on the other Shanghai-Hong Kong Stock Connect, market by using local securities fi rms or investors’ great interest to buy shares at dealers. On December 5, 2016, Shenzhen- Shanghai stock market contrasts sharply Hong Kong Stock Connect was offi cially with their lack of interest about buying launched. It has replicated the successful shares at Hong Kong Stock market. Th e experience of the pilot Shanghai-Hong former indicated that the attraction of Kong Stock Connect and served as the A-share market was far bigger than another connectivity mechanism between the Hong Kong stock market at that time the domestic stock exchange and that in and a leveraged bull had just started. Hong Kong. Th e launch of Shenzhen- Two years later, against the background Hong Kong Stock Connect is another of mounting deprecation pressure on major and meaningful step forward in RMB, it is hard to tell where the A-share boosting inter-connectivity between the market will go and if the old success can domestic fi nancial market and that of be repeated. Hong Kong. According to offi cial statement, Shenzhen Stock Exchange announced on November 25 altogether 417 shares under Shenzhen-Hong Kong Stock Connect program including 100 from Hong Seng Composite Largecap Index, 193 from 87 Hong Seng Composite Midcap Index, USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Opening-up they have better return on investment of interbank market than cash; Th ird, they boasts high liquidity and can be easily converted into cash. and issuance Bonds with these three characteristics of Panda bond will become global safe assets and thus investment targets for many countries By analyzing the opening-up of as international reserves. From a long- interbank market, we can clearly see term perspective, opening-up of China’s cooperation between RMB interna- interbank market is also the process to tionalization and opening-up of capital promote RMB-denominated bonds to account. become global safe assets and thus make China’s interbank market is composed RMB an international reserve currency. of bond market (including securitization products), paper market, foreign exchange A. Policies to promote market and interbank loan market. For RMB internationalization, bond market opening-up of the interbank is the most important one. Hence, the bond market interbank market discussed below is China began to open the domestic mainly about bond market. During the bond market to overseas institutions in course of RMB internationalization, August 2010 when People’s Bank of China a key problem has arisen as more and adopted a pilot policy to allow foreign more RMB fl ew into overseas markets central banks or monetary authorities, and were held by non-residents that overseas clearing banks for RMB business, is how to provide non-residents with and overseas participating banks for RMB ample RMB investment channels. Inter- settlement of cross-border trade to invest national experience indicates that the in the interbank bond market with RMB most important investment channel funds. Th e scope of investors has since for an international currency is the been gradually expanded. capital market of the issuing country Between 2011 and 2012, China Secu- including the bond market and the stock rities Regulatory Commission and market. In terms of promoting RMB People’s Bank of China have released internationalization, opening-up of new rules to allow QFII/RQFII to enter China’s interbank market is to provide the interbank market but the approval non-residents with investment channel procedure remains time-consuming. to RMB-denominated bonds. In March, 2013, aft er issuing "Notice For currency internationalization, on issues concerning investment in the the more important value of opening- interbank bond market by qualifi ed up of interbank market is to promote foreign institutional investors", People’s the currency to become an international Bank of China began to accelerate reserve currency. One of the key symbols of approval of the entry of QFII/RQFII into successful currency internationalization the interbank market. is that the currency has become an In June 2015, People’s Bank of international reserve currency as the China allowed overseas clearing US dollar, euro and pound did. Most banks for RMB business and overseas international reserve currencies will not participating banks for RMB settlement be saved in the form of cash but exist of cross-border trade to invest in repo. in the form of bonds denominated with In July 2015, People’s Bank of China loosened rules on investment in the 88 these currencies. And these bonds have three characteristics: First, they have high interbank bond market by three types of credit rating and low default risk; Second, sovereign institutions including foreign THE INTERNATIONALIZATION OF RMB: CHINA’S EXPERIENCE

800 2.7 600 1.8 400 0.9 200 0 0 2014-06 2014-07 2014-08 2014-09 2014-10 2014-11 2014-12 2015-01 2015-02 2015-03 2015-04 2015-05 2015-06 2015-07 2015-08 2015-09 2015-10 2015-11 2015-12 2016-01 2016-02 2016-03 2016-04 2016-05 2016-06 2016-07 2016-08 2016-09 2016-10 2016-11 Government bond Policy bank bond Corporate bond Mid-term note Others Share of the interbank market (right scale)

Figure 6. Bonds held by overseas institutions (bn yuan) and their market share (%) Source: People’s Bank of China central banks or monetary authorities, central banks and similar institutions international fi nancial organization and to enter the interbank bond market and sovereign wealth funds by abolishing foreign exchange market, including ex-ante approval of access and quota more opening-up in terms of investment and expanding the scope of investment quota, investment products and free to include cash bond, bond repurchase, remittance of funds. By October 2016, securities lending, bond forward, interest 207 foreign commercial banks, non- rate swap and forward rate agreement. bank fi nancial institutions, investment Since the beginning of 2016, People’s managers of fi nancial institutions and Bank of China has considerably other institutional investors have entered accelerated opening-up of the interbank China’s interbank bond market. bond market in terms of expanding the scope of investors and investment B. Transactions of foreign products. In February 2016, China institutional investors in the extended access to the interbank bond market to more foreign institutional interbank market investors including overseas commercial As China accelerated the pace of RMB banks, insurance companies, securities internationalization and opened up its fi rms, fund management companies interbank market, the number of foreign and other asset management agencies. investors in China’s interbank market It also clarifi ed the entry procedure and has increased rapidly since 2010. By regulatory measures for foreign central analyzing statistics from People’s Bank of banks and similar institutions, restating China, we fi nd that the open interest held that overseas institutional investors are by foreign institutions and their trade subject to registration management; volume are growing amid fl uctuation. quota approval is abolished; foreign In terms of the type of bonds, foreign central banks and similar institutions institutional investors mainly hold rate do not need authorization or approval securities among which government for outward remittances of funds related bonds and policy bank bonds accounted to their securities and foreign exchange for more than 90%. In terms of trade investment. In April, China’s central volume, foreign investors have taken an 89 bank issued the procedure for foreign increasingly big share of the interbank USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Less than 1

Government bond

Corporate bond 39

Mid-term note 56 Policy bank bond

Others 3 2

Figure 7. Th e composition of bonds held by foreigh investors in the interbank market (by November 2016), % Source: People’s Bank of China

market with their open interest reaching proportion of credit bonds held by foreign 747.128 billion yuan, about 2.5% of the institutions is related to their strict risk total depository trust in the market. control over cross-border investment. In terms of spot trading of bonds, the Since the credibility of domestic credit transaction volume has increased year rating agencies is not well accepted in by year while the volume of buy is rising the international market, most foreign amid fl uctuation and the volume of sell institutions only invest in sovereign remains fl at. Th e following fi gure clearly rating products. As the composition of shows that there is an obvious rise in foreign institutional investors became the total trading volume by foreign more diversifi ed in recent years, the institutions in the interbank bond market amount of corporate bonds and medium- (Figure 6). term notes they held went up too. Th e According to statistics from People’s amount of corporate bonds they held Bank of China, by the end of November increased from 6.987 billion yuan at the 2016, 56% of all the bonds held by foreign end of 2013 to 15.899 billion yuan by institutions are government bonds, the end of November 2016 while that of 39% policy bank bonds (among which medium-term notes soared from zero to bonds issued by China Development 18.862 billion yuan (Figure 7). Bank, Agricultural Development Bank of China and Export-Import Bank of C. Issuance of Panda Bond China accounted for 21%, 10% and 8% Panda Bond refers to RMB-deno- respectively), 3% and 2% medium-term minated foreign bonds that foreign notes and corporate bonds, and the institutions issued in China. China began total of government bonds they held has the pilot program of panda bonds in reached 168.3 billion yuan. A research October 2005 when International Finance 90 report by China International Capital Corporation and Asian Development Corporation Limited shows that the low Bank had issued RMB-denominated THE INTERNATIONALIZATION OF RMB: CHINA’S EXPERIENCE

120 4.8

90 3.6

60 2.4

30 1.2

00 2005 2006 2009 2014 2015 2016 Sovereign government Financial institution Weighted average International organization Non-financial enterprise coupon rate (right scale)

Figure 8. Statistics on the size of issuance of Panda bonds between 2005 and November 2016 (bn yuan) and weighted average coupon rate (%) Source: Wind Database bonds worth of 1.13 billion yuan and has issued debt fi nancing instruments 1 billion yuan respectively to set a in China’s interbank market. In 2015, precedent for foreign institutions to issue the National Development and Reform panda bonds in this country. However, Commission, the Ministry of Foreign because of regulatory restrictions over Aff airs and the Ministry of Commerce issuance approval and usage of fund, the jointly issued "Vision and Actions on panda bond market developed slowly in Jointly Building Silk Road Economic Belt following years. Between 2005 and 2014, and 21st-Century Maritime Silk Road", the total issuance of the panda bond stressing that "We will support the eff orts market was only 6 billion yuan. of governments of the countries along As RMB internationalization ac- the Belt and Road and their companies celerated, regulatory policies have been and fi nancial institutions with good changed to boost development of the credit-rating to issue Renminbi bonds panda bond market. Th e scope of issuers in China". In September, 2015, HSBC has been expanded; cross-border use and Bank of China (Hong Kong) of funds raised from bond issuance and successfully issued the fi rst panda bond funds for paying interest and principal in the domestic interbank bond market. are allowed for foreign institutions and rules on cross-border RMB settlement In December 2015, the government of has been made clear; a domestic- South Korea issued the fi rst sovereign international dual rating system has been panda bond worth 3 billion yuan to adopted; use of accounting and auditing become the fi rst foreign government methods which are in accordance with allowed to issue RMB-denominated domestic accounting standards and bonds in China. Driven by both policy approved by China’s Ministry of Finance support and declining interest rates, the has been allowed. In March, 2014, panda bond market has expanded rapidly Germany’s Daimler AG successfully as both the scope of issuers and the size issued one-year Private Publication Notes of bond issuance have been enlarged. in the interbank market to become the Th e issuance of panda bonds totaled 91 fi rst foreign non-fi nancial corporate that 13 billion yuan in 2015 and has soared USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Electricity, heat, gas and water 4 7 production and supply 3 Real estate 6 Construction Transportation, warehouse 21 and postal service 42 Finance Manufacturing 14 Sovereign government Comprehensive trade 1 1 Leasing and business service

Figure 9. Th e industrial distribution (issuance) of Panda bonds, % Source: Wind Database

to 124.82 billion yuan in the fi rst 11 institutions to issue bonds in the panda months of 2016. bond market, diversify the structure By the end of November in 2016, of issuers and promote use of RMB altogether 36 foreign enterprises, settlement in cross-border trade. international organizations and sove- reign governments have issued 79 Construction panda bonds through public or private of RMB Settlement publication in the interbank bond market and the exchange bond market, including System for Cross- commercial paper, medium-term note, border Transaction private publication note, commercial bank bond, international institutional A settlement system for cross-border bond, corporate bond and private bond. payment is infrastructure construction Panda bonds have gradually developed for internationalization of a currency. into a new channel of diversifi ed fi nancing China’s original RMB settlement for for foreign institutions (Figure 8). cross-border payment relied mainly on In terms of the industrial distribution the two channels of clearing banks for of the issuers of panda bonds, the RMB business in Hong Kong and Macao issuers have covered 9 major industries and domestic agency banks both of which including real estate sector, construction, would settle accounts by using China transportation, warehouse and postal National Advanced Payment System, a service, fi nance and manufacturing. system consisting of High Value Payment Among them, real estate sector, manu- System and Bulk Electronic Payment facturing and fi nance rank among the System. Overseas banks will open RMB largest issuers while the number of their settlement accounts in agency banks or issuance accounted for 34%, 20% and clearing banks and transmit cross-border 19% of the total and the size of their payment information via SWIFT. Due to issuance 42%, 21% and 14% of the total factors such as the time lapse for running the system and translation of code, the 92 respectively (Figure 9). More eff orts are needed to explore original channel for RMB cross-border how to attract more countries and foreign settlement is not very effi cient. Besides, THE INTERNATIONALIZATION OF RMB: CHINA’S EXPERIENCE

CNAPS cannot separate domestic support from HVPS and interbank interbank payment from cross-border lending. Second, CIPS provide domestic RMB payment settlement to ensure the direct participants with special line safety of the system. access that allows them to have one- Since it launched pilot cross-border point access, concentrate settlement and RMB business in 2009, China has already shorten path of settlement. Th ird, by done cross-border RMB payment bus- adopting the internationally-recognized iness with 174 countries. Th e amount of ISO20022 standard for fi nancial services RMB settlement in cross-border trade has messaging and using the unifi ed and soared from less than 200 billion yuan in standardized Chinese Commercial Code, 2010 to 4.4 trillion yuan in the fi rst ten CIPS has taken into full consideration the months of 2016, making it impossible need of code switching with the current to fully meet the need for development SWIFT code to support transmission in of RMB business with CNAPS. It is both Chinese and English so as to raise necessary to integrate the existing RMB the speed of code-switching. Fourth, payment clearing channel and resources the operation period of CIPS has been and enhance infrastructure construction extended from 9:00 to 20:00 to meet the for the fi nancial system. To ensure safety, need of the development of RMB business stability and effi ciency of RMB cross- in multiple time zones. border payment settlement, People’s Bank of China has begun to establish Cross- Summary Border Interbank Payment System in 2012 in line with "Principles for Financial RMB internationalization faces many Infrastructure". Th e CIPS (Phase I) was challenges today as the country has not yet offi cially put into operation on October achieved full capital account convertibility 8, 20152. and RMB depreciation expectation Th e main functions of CIPS (Pha- is rising. Strengthening cooperation se I) include providing settlement for among BRICS countries to promote RMB cross-border payment by domestic internationalization of their currencies and foreign institutions and supporting is not only of vital importance for RMB RMB cross-border settlement, cross- internationalization but also a major step border direct investment, cross-border to propel diversifi ed development of the fi nancing and personal remittance in international monetary system. the fi nancial market. CIPS can provide Between 2009 and 2016, RMB participants with highly effi cient cross- internationalization has achieved border, cross-time-zone, cross-currency remarkable progress but its foundation payment settlement via its connection for development is not solid. According with HVPS. to statistics from SWIFT, RMB has CIPS (Phase I) has raised effi ciency become the fi ft h largest global payment of settlement in following aspects: First, currency, ranking only behind dollar, CIPS processes client remittances and euro, pound and yen and boasting a remittances by fi nancial institutions in market share of 4%. According to a survey real-time gross settlement with liquidity by Bank for International Settlement, the proportion of RMB in global transaction 2 Construction of CIPS is carried out in two phases, and CIPS (Phase I) provides real-time volume has increased from 0.1% in gross settlement for cross-border trade settlement, 2004 to 4% in 2016 while its ranking cross-border direct investment and other cross- rose from the 35th to the 8th. Clearly, border RMB settlement. CIPS (Phase II) will RMB has assumed a crucial role in the provide mixed settlement that is more liquidity- 93 saving to comprehensively support RMB cross- international monetary system. But one border and off shore settlement. of the key driving forces to promote RMB USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

internationalization under the condition In March 2014, the daily range of RMB of incomplete convertibility of capital exchange rate fl uctuation enlarged to account is the spread of foreign exchange 2% in both directions. Since then, RMB rates and interest rates between domestic appreciation expectation has plummeted. and overseas markets. As the exchange Aft er the "August 11" foreign exchange rate of RMB approaches the equilibrium reform, onshore spot rate began to be level, the spread of foreign exchange rates higher than off shore exchange rate and between domestic and overseas markets RMB depreciation expectation emerged. gradually disappeared. And the expansion Within just a year, RMB appreciation of the daily range of RMB exchange rate expectation was replaced by strong fl uctuation has further diminished the devaluation expectation, and a large part room for exchange rate arbitrage between of RMB internationalization business domestic and overseas markets. Before based on cross-border arbitrage also RMB internationalization has an inherent declined. driving force, it is unavoidable that the Th ough the proportion of RMB process will suff er short-term turbulence settlement in cross-border trade keeps and even setbacks. rising, RMB settlement does not Aft er the "August 11" foreign ex- necessarily mean that the trade is RMB- change rate reform in 2015, RMB denominated. When the exchange rate internationalization has been in the of RMB turned from appreciation to doldrums for a while. Th e average growth depreciation, many domestic importers rate of RMB settlement in cross-border who had used RMB for settlement would trade was 55% between 2010 and 2014 be required by their foreign counterparts while that of RMB deposits in Hong Kong to pay in US dollar while domestic reached 120%. Nevertheless, between the exporters were required by foreign "August 11" foreign exchange reform and counterparts to allow payment in RMB. October 2016, the monthly total of RMB Besides, when off shore RMB is cheaper, cross-border settlement declined from many domestic exporters incline to use 775 billion yuan to 360 billion, on average US dollar for settlement in off shore down 30% per month over the same markets and then recycle RMB back into period last year. Meanwhile, the amount the domestic market. Historical data of RMB deposits in Hong Kong dropped shows that the accumulation of off shore from 1 trillion yuan to 662.5 billion yuan, RMB deposits in Hong Kong is largely on average down 25% per month over the a result of RMB cross-border arbitrage. same period last year. Th e new issuance As RMB appreciation expectation is of dim sum bonds in 2016 was 46.9 billion gone and two-way fl uctuation of RMB yuan and its growth rate declined by 50%. exchange rate widens, there will be less Th ere are mainly three reasons why RMB such arbitrage and hence less off shore internationalization was in the doldrums. RMB deposits in Hong Kong. First, expansion of the daily range Second, the cyclical rise of US dollar of RMB exchange rate fl uctuation and will reduce the attractiveness of RMB the change of expectation over RMB while both domestic and overseas players appreciation narrowed cross-border will tend to hold more US dollars. In 2015, exchange rate arbitrage space. Between the third quarter statistics showed that September 2012 and March 2014, RMB the proportion of banks buying foreign central parity was fi xed relatively lower exchange to their total foreign receipts than onshore and off shore spot rates and declined to 43% while their selling 94 onshore spot rate was also relatively lower foreign exchange accounted for 67% of than off shore spot rate, indicating strong their total foreign payment. Th is indicates expectation over RMB appreciation. that enterprises were more willing to hold THE INTERNATIONALIZATION OF RMB: CHINA’S EXPERIENCE

US dollars. On one hand, because the US remain low, onshore and off shore RMB dollar is on the track of appreciation and interest rates have gradually converged overseas exporters prefer settlement in US and domestic enterprises lost their dollar, Chinese enterprises and importers interest in bond issuance in Hong Kong. need to buy foreign exchange from banks Th e issuance of dim sum bonds in 2016 for payment and the proportion of bank was only 46.9 billion yuan, down by selling foreign exchange to their foreign 50%. If RMB depreciation expectation payment has thus signifi cantly increased. persists, the market of dim sum bonds On the other hand, because of the relative will continue to shrink. depreciation of off shore RMB in Hong RMB internationalization has entered Kong against onshore RMB, it pays for a new development phase. In a long- enterprises to buy foreign exchange term view, China’s huge economic in the Chinese mainland. As a result, development potential and room for the purchase of foreign exchange by market-oriented reforms as well as the enterprises has increased while their sale need of a diversifi ed monetary system to of foreign exchange to banks declined. support global fi nancial stability would Th ird, as the RMB fi nancing cost gap be the fundamental driving forces behind between overseas and domestic markets RMB internationalization. However, in narrows, dim sum bonds become less the short term, RMB internationalization attractive to domestic enterprises. In the faces many challenges and needs to international monetary system, RMB adjust its development mode. Whether is still a risk currency. In their currency market players will use and hold RMB arbitrage strategies, investors tend to use is determined by whether they can Japanese yen or US dollar as the fi nancing obtain benefi t or lower risk. Th e recent currency and choose Australian dollar trend of market change keeps reducing or emerging market currencies as the the marginal benefi t of holding RMB. investment currency. As a high-yield risk On one hand, there is limited room for currency, RMB is more than oft en an RMB appreciation in the short term as investment currency. When expectation China’s economic growth is slowing on RMB appreciation is strong, investors down, import and export becomes who hold dim sum bonds can obtain not balanced, and RMB exchange rate has only interest income but also the potential basically reached an equilibrium level. benefi t of appreciation. When expectation On the other hand, there is an about-turn on RMB depreciation prevails, investors in global liquidity and RMB liquidity who hold dim sum bonds will require and the divergence between China’s higher interest income to make up for monetary policy and the US monetary the potential exchange rate loss in the policy will widen in the future. As a result, future. Hence, the interest rate of dim the narrowed interest rate gap between sum bonds will rise with the depreciation China and the US and the rise of US expectation. dollar will keep reducing the attraction Liquidity in China’s monetary of RMB. Moreover, since processing market was quite tight in 2013 and many trade still accounts for a large share of enterprises inclined to issue dim sum China’s trade and domestic exporters bonds in the off shore market. Because of generally don’t have much pricing power, RMB appreciation expectation at that time it is diffi cult to further increase the ratio and relatively higher domestic interest of RMB-denominated trade. In terms rates, these enterprises were enthusiastic of channels for capital fl ow, offi cial about issuance of dim sum bonds. But as development aids or investments may, to RMB depreciation expectation prevails a certain extent, unleash RMB liquidity. 95 and domestic short-term interest rates But domestic fi nancial institutions’ lack USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

of international competitiveness and fintech-a-brave-new-world-for-the- experience in managing exchange risks fi nancial-sector/ has limited their role in promoting RMB 6. Liu D., Gao H., Xu Q., Li Y., Song S. internationalization. All evidences show Th e ‘Belt and Road’ Initiative and the that RMB internationalization has entered London Market – the Next Steps in a new phase of stable development. China Renminbi Internationalization. Part 1: needs to gradually upgrade industrial Th e View from Beijing // Chatham and trade structure of its real economy House. Research Paper. 2017. January. in the future to raise the potential of URL: http://www.chathamhouse.org/ sites/files/chathamhouse/publications/ RMB internationalization. Also, during research/2017-01-17-belt-road- the course to realize full convertibility of renminbi-internationalization-liu-gao- capital account, China needs to maintain xu-li-song.pdf ample prudential regulatory tools to 7. Liu D. Internationalization of Chi- prevent excessive cross-border capital na’s Bonds Markets, Development of fl ow. Off shore RMB Center and Provision of Global Safe Assets // Enter the Dragon: References China in the International Financial System / D. Lombardi, H. Wang (eds.) // 1. Cermeno J. S. Blockchain in fi nan- CIGI Press. 2016. P. 259–290. cial services: Regulatory landscape and 8. Liu D. Off shore issuance of China’s future challenges for its commercial Local Government Bond // Zhongguo application // BBVA Research. Working Jinrong (China Finance). 2016. No. 17. paper. 2016. No. 16/20. URL: http:// P. 76–77. www.bbvaresearch.com/wp-content/ 9. Song S., Liu D. Th e EIB’s NonCredit uploads/2016/12/WP_16-20.pdf Business for Small and Medium 2. Digital Currency // BIS. Committee Enterprises and Its Implication for on Payments and Market Infrastructures. the AIIB // Yinhangjia (Th e Chinese 2015. URL: http://www.bis.org/cpmi/ Bankers). 2016. No. 10. P. 108–111. publ/d137.pdf 10. Th e future of fi nancial infra- structure. An ambitious look at how 3. Gao H., Yu Y. Internationalization blockchain can reshape fi nancial ser- of the renminbi // Currency inter- vices // World Economic Forum. An nationalisation: lessons from the global Industry Project of the Financial Services fi nancial crisis and prospects for the Community. 2016. August. URL: http:// future in Asia and the Pacifi c // BIS. www3.weforum.org/docs/WEF_The_ BIS Papers. 2011. No. 61. P. 105–124. future_of_fi nancial_infrastructure.pdf URL: http://www.bis.org/publ/bppdf/ 11. Th orsten K., Jeremy K. Blockchain bispap61.pdf Technology — What’s in Store for 4. He D., Habermeier K., et al. Virtu- Canada’s Economy and Financial al Currencies and Beyond: Initial Consi- Markets? // C.D. Howe Institute. Com- derations // IMF. Staff Discussion Note. mentary. 2017. No. 468. URL: http:// 2016. No. SDN/16/03. URL: http://www. www.cdhowe.org/sites/default/files/ imf.org/external/pubs/ft/sdn/2016/ attachments/research_papers/mixed/ sdn1603.pdf Commentary_468_0.pdf 5. Lagarde C. Fintech — A Brave 12. Wu Y. Analysis of the currency swap approach of the RMB internationalization New World for the Financial Sector? 96 // Shanghai Jinrong (Shanghai Finance). // IMF. IMFBlog. 2017. March 21. 2013. No. 4. P. 32–36. URL: http://blogs.imf.org/2017/03/21/ TOWARDS NATIONAL CURRENCY USAGE IN INTERNATIONAL TRANSACTION SETTLEMENTS... Chapter 6

Towards National Currency Usage in International Transaction Settlements: Specific Experiences in BRICS - the Case of South Africa1

The case for SA Exchange requires prior approval of the financial control offi cial Financial Surveillance Department. Any Authorised Dealer wishing to facilitate transactions of the nature South African Reserve Bank exercises outlined above, requires the approval of fi nancial control in the country (Table the Financial Surveillance Department 1). Foreign fi rms, fi nancial institutions, and will have to comply with the specifi c offi cial institutions and individuals reporting requirements prior to approval can hold rand and rand-denominated being granted. instruments in amounts they deem useful Institutional investors may not and prudent. Th ere are no restrictions on transfer rand off shore. In order for an foreigners for holding South African rand institutional investor to participate in and rand-denominated instruments. Th e rand-denominated instrument issued section on capital transactions in Table 1 off shore, the rand value would have to outlines the requirements for foreigners be converted to a foreign currency, and to hold South African rand and rand- the equivalent foreign currency value denominated instruments. Th e desire to hold rand and rand-denominated has to be reconverted back to rand in an fi nancial instruments stems from the need off shore market to purchase the desired to access a store of value as a function of instrument. Th e initial conversion of the rand (Tavlas, 1992). If this were the rand to foreign currency for the purchase case the rand could assume international of rand-denominated instruments issued reserve currency status for those who off shore could be hedged locally but the hold these instruments as a store of value. subsequent conversion back to rand to Th e breadth and depth of the national purchase rand-denominated instruments fi nancial market is a necessary benchmark issued off shore poses a price risk and may indicator of the ability of a currency to be be hedged either in foreign market or on utilized as a reserve currency. However, the JSE by utilising approved foreign- it is not a suffi cient condition to achieve referenced derivative products traded in 2 this status as other factors play an equally rand and issued by the JSE . important role as was demonstrated in the All fi nancial institutions should fi nal ascension of the Chinese renminbi ensure that their investments are in com- to international reserve currency status in pliance with the Financial Services 2016 aft er many years of trying. Boards requirements and regulations. Any foreign entity wishing to list Institutional investors are permitted to instruments on the Johannesburg Stock invest in rand-denominated products 2 See Corporates // South African Re- 1 Ronney Ncwadi — Nelson Mandela serve Bank. URL: http://www.resbank.co.za/ 97 Metropolitan University; Jaya Josie — Human RegulationAndSupervision/FinancialSurveillanceA Sciences Research Council. ndExchangeControl/FAQs/Pages/Corporates.aspx USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Table 1 South African Reserve Bank Summary of Financial Controls Legal Basis Exchange Control Regulations 1961 (with amendments) Exchange rate agreement Floating Exchange rate A South African resident over the age of 18 years is entitled to special discretionary allowance within an overall limit of ZAR 1 million per Residents calendar year. Th e special Discretionary allowance can also be used for purposes of investment Resident A natural person can open a foreign currency account for permissible accounts purposes Non- Any income earned on investments can be transferred abroad Residents Non-Resident Foreign fi rms can open rand accounts Accounts Exchange control All forex brought from abroad must be exchanged for rand within 30 Bank Notes days of arrival Transactions settled by an Authorised dealer, usually bank supported Export-Import by an invoice and customs clearance certifi cation for goods received. transactions Advance payments possible on the strength of an invoice but SARS (Customs) documentation also required if goods exceed ZAR 50,000 Residents can invest up to ZAR 1,000,000 abroad without SARB approval. Outward capital investment of ZAR 1–10 million per calendar year requires clearance from the SARB and SARS (tax). Funds and collective investment schemes cannot invest more than 25% of their portfolios outside of South Africa. Residents An additonal 5% allowance of their total retail is granted for foreign currency denominated African securities. Corporates can invest up to ZAR 1 billion per annum. Any investments > ZAR 1 billion per annum require SARB approval. Also at least 10% of the targets voting rights must be acquired Non-residents may freely invest in South Africa, provided that suitable documentary evidence is viewed by the bank concerned, in order to ensure that such transactions are concluded at arm’s length, at fair market related prices and are fi nanced in an approved manner*. (ii) Such fi nancing must be in the form of the introduction of foreign Non- currency or rand from a Non-Resident account (i.e. a rand account Residents

Capital Transactions opened by a non-resident at a South African bank). (iii) Any income earned on the investment may be transferred abroad. (iv) Should a non-resident disinvest from this country, the local sale or redemption proceeds of non-resident owned assets in South Africa would be regarded as freely transferable. (SARB, 2016) Residents can borrow from abroad with conditions**. Resident Can issue loans outside of the CMA provided they are not reinvested Loans or reintroduced as loans in the CMA Local Subsidiaries of foreign companies can only give parent Non-Resident 98 companies loans in lieu of dividends or profi ts and under SARB outward loans approval TOWARDS NATIONAL CURRENCY USAGE IN INTERNATIONAL TRANSACTION SETTLEMENTS...

Table 1 (Th e completion) Spot Good Transaction Forward Liquidity Good (1–6 months) transaction Source: IMF (2014); BIS (2016); SARB (2017) Note: * Foreign fi rms can hold fi nancial instruments provided their schemes are registered with Collective Investment Schemes SA. A foreign investment fund which is so registered may be marketed publicly in South Africa. In order to qualify for South African registration, a foreign fund must have an investment policy which is consistent with the requirements set out under CISCA (Norton Rose Fulbright 2016). ** Th e term of the loan must be at least one month. (ii) Th e interest rate in respect of third party foreign denominated loans may not exceed base lending rate plus 2% and in respect of shareholders’ loans the base lending rate of the country of denomination. (iii) Interest rate in respect of rand denominated loans may not exceed prime lending rate plus 3% on third party loans or the base rate, in the case of shareholders’ loans. (iv) In respect of trade fi nance facility loans, interest payments of up to prime plus 10%, which includes shipping and confi rming fees, handling costs, administration fees, bank charges, commissions and raising fees (all-in costs) will be approved. (v) Th e loan funds to be introduced may not be sourced from a South African resident's foreign capital allowance, foreign earnings retained abroad, funds for which amnesty had been granted and/or foreign inheritances. (vi) Th ere may not be any direct/indirect South African interest in the foreign lender. (vii) Th e loan funds may not be invested in Sinking Funds. (viii) No upfront payment of commitment fees, raising fees and/or any other administration fees are payable by the borrower (SARB). issued abroad, or foreign currency ensure the consistent classifi cation of fo- denominated instruments issued by local reign exposure, institutions are required entities as part of their foreign portfolio to report their assets on a look-through investment allowances on a condition basis. that the requirements of the fi nancial Non-residents may freely invest in services board are met as is the case with South Africa, provided that suitable respect to investments in any other documentary evidence is viewed by the fi nancial product3. bank concerned, in order to ensure that It should be noted that compliance such transactions are concluded at arm’s with the foreign exposure limits on foreign length, at fair market-related prices and portfolio investment does not preclude are fi nanced in an approved manner. (ii) an institution from also having to comply Such fi nancing must be in the form of with any relevant prudential regulations the introduction of foreign currency or as administered by the Financial Services rand from a Non-Resident account (i.e. Board4. a rand account opened by a non-resident Foreign assets, for exchange control at a South African bank). (iii) Any purposes, are defi ned as the sum of foreign-currency denominated assets income earned on the investment may and rand-denominated foreign assets be transferred abroad. (iv) Should a non- acquired indirectly through investment resident disinvest from this country, the with another domestic institution. To local sale or redemption proceeds of non-

3 resident owned assets in South Africa See Guidelines: South African Institutional 5 Investors // South African Reserve Bank. 2016. would be regarded as freely transferable . August 10. URL: http://www.resbank.co.za/ RegulationAndSupervision/FinancialSurveillance 5 See Inward listings by foreign entities on AndExchangeCon-trol/Guidelines/Guidelines%20 South African exchanges // South African Reserve and%20public%20awareness/Guidelines%20 Bank. Exchange control manual. 2016. URL: http:// South%20African%20Institutional%20Investors.pdf www.resbank.co.za/RegulationAndSupervision/ 99 FinancialSurveillanceAndExchangeControl/ 4 Ibid. EXCMan/Section%20W/Section%20W.pdf USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

Table 2 Banks authorised to deal in foreign currency in SA ABSA Bank Limited Investec Bank Limited Albaraka Bank Limited Habib Overseas Bank Limited Bank of Baroda JP Morgan Chase Bank (Johannesburg Branch) Bank of China Nedbank Limited Johannesburg Branch Bank of India Mercantile Bank Limited Bank of Taiwan South Société Générale Africa Branch Bidvest Bank Limited Standard Chartered Bank — Johannesburg Branch BNP Paribas SA– State Bank of India South Africa Branch Canara Bank Th e South African Bank of Athens Limited China Construction Bank, Sasfi n Bank Limited Johannesburg Branch Citibank, N.A., South Africa Standard Chartered Bank — Johannesburg Branch Deutsche Bank AG, State Bank of India Johannesburg Branch FirstRand Bank Limited Th e Standard Bank of South Africa Limited Source: SARB (2016)

The case for SA foreign ex-change proceeds to the central or currency management local bank, authorization requirements, quantitative limits or indirect methods. Exchange controls are most commonly Th e forex governing authority in imposed because of concerns about SA is the National Treasury under the outward fl ows, but controls can also be Minister of Finance and any designated imposed to restrict inward fl ows for e.g. offi ce in the Treasury. Th e exchange an infl ux of funds that could hurt the controls regulate and restrict the outfl ow economy. and infl ow of capital in South Africa. All In South Africa, foreign currency is forex transactions are subject to these handled by what the Central Bank has regulations, whether you are traveling, designated as Authorised dealers and emigrating, immigrating, investing, Authorised dealers with limited authority. returning to South Africa, importing or Authorised dealers are banks and those exporting goods and services (Norton with limited authority handle travelling Rose Fulbright, 2017). Th e policy applies and tourism arrangements. As such the to the Non-Resident Area being any bulk of trading is done by the banks. Most countries falling outside of the CMA forex trading takes place in the banking (Swaziland, Namibia, Lesotho). sector. Most Authorised dealers are Exchange controls can take many banks, and that it is where forex trading forms, but their immediate aim is to takes place. Below is a list of Authorised restrict the buying and selling of a national Dealers (Table 2). currency or to preserve foreign currency Th ere is a limited number of Banks reserves. Controls might include a ban that off er direct ZAR/RUB and ZAR/BRL on the conversion of proceeds of certain currency pairs. Th e Table 3 is in general 100 assets or by certain categories of person, agreement with the notion that real and an obligation to surrender foreign ruble are the least traded currencies TOWARDS NATIONAL CURRENCY USAGE IN INTERNATIONAL TRANSACTION SETTLEMENTS...

Table 3 Direct currency pair for top 5 forex Banks Bank Ruble Rupee Real Renminbi ABSA ●● Standard ●● ●

Nedbank ●● FNB ●●

Capitec

Bidvest ●● ●

● — Represents where currencies are traded directly. Th e ruble and real are traded via a vehicle currency predominantly the US dollar. among the BRIC in South Africa. Th ese BRICS for the month of April 2016. Th is are the off erings of the top 5 local banks might explain why Banks do not trade real in South Africa as far as their forex trade and ruble without a currency vehicle (US is concerned. dollar). Th e explanations of why there are few ZAR/RUB and ZAR/BRL direct trades lie Rand as a reserve in the calculation the rand foreign currency currency basket and in sphere of trade in general. Th e trade weights utilised to calculate the rand Being able to invoice South African foreign currency basket attest to the size of exports in rand to export partners and ruble trade that takes place because of trade third parties constitutes making the between South Africa and Russia. Th e rand a reserve currency. A cursory look diagram below refers. Th e Russian ruble is at the requirements for this and the level not included in the rand currency basket. of currency restrictions on rand trade Th is might explain why there is weak ruble shows that as a currency it might not trade on South African Markets. China, have suffi cient credentials to be a reserve Brazil and India represent 12.46%, 1.37% currency anytime soon. and 2.01% of the index respectively. Th ese Th e confi dence in the stability of currencies are traded without the aid of a a currency is obviously a necessary vehicle currency in South African Markets. qualifi cation. If a currency in question Th is diagram illustrates the biggest is quite unstable and tends to fl uctuate trading partners for South Africa. China, substantially, it will not work as a store India, and Brazil are signifi cant in the of value. It will also be avoided to use weighting of the currency index, whereas a currency as a unit of account and Russia is not included (Figure 1). a medium of exchange in trade and Th e succeeding diagram illustrates a fi nancial transactions due to a signifi cant snapshot of rand exchange with BRICS risk of exchange rate changes. Moreover, countries for the month of April 2016 once a currency becomes a dominant (Figure 2). China holds the bulk of the vehicle currency in foreign exchange volume, with 79% of rand trade within the markets, the currency will be used as BRICS. India and Brazil have 15% and 6% a major international currency due to of rand trade respectively in the month. economies of scale. Specifi cally, the larger 101 Russia only has 0.6% of rand trade in the the volume of transactions is in foreign USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

1 Euro area 10 United States 2 3 China

35 United Kingdom 10 Japan

11 Switzerland Australia 15 13 Zambia

Other countries Figure 1. SA main trade partners: share of total trade, % Source: Authors' calculations based on SARB data (2016)

Less than 1 6

15 China Brazil

India

79 Russia

Figure 2. Average daily rand traded turnover for BRICS economies as of April 2016, % Source: BIS triennal survey (2016)

exchange markets, the lower the cost of used in cross-border settlements transactions. include the Hong Kong dollar, While the world is moving towards Singapore dollar, and Th ai baht. integrated fi nancial markets, some 2. Many economies have some restrictions on foreign exchange and restrictions on foreign exchange or capital accounts transactions persist. capital transfer, although the level of Th ese restrictions include: the strength of the constraints diff er 1. Some economies prohibit cross- by country. 102 border trade settlement in their own 3. Some economies uphold the real currency. For example, 3 currencies demand principle for foreign exchange TOWARDS NATIONAL CURRENCY USAGE IN INTERNATIONAL TRANSACTION SETTLEMENTS...

hedging in the domestic market and recognition as a world’s factory (Galvao, require documentary evidence of 2013). underlying transactions. South Africa and India share a strong 4. Some economies control the foreign bilateral relationship and the main exchange positions of the authorized objective is to expand and diversify banks and fi nancial institutions trade and economic relations (Lucey (ASEAN, 2010). and Makokera, 2015). India and China South Africa has good macro- emerged as South Africa’s most important prudential policies. Th e Reserve Bank and trading partners in BRICS (Onyikwena, treasury are perceived to be independent Taiwo and Uneze, 2014). (Bravura, 2017). Cross-border settlement Th e strong trade ties between South transactions in South African rand is not Africa and India are linked to its historical prohibited; however, the SARB prefers to and cultural ties. Th ese two countries had have such transactions settled in US dollars a long relationship during South Africa’s instead. Th ere is a level of restriction on liberation struggle. India was the fi rst to enact trade sanctions against the apartheid foreign exchange and capital transfer government in 1946 and established a as Table 1 illustrates. In addition, the complete embargo on South Africa. India relative small volumes of South African actively worked for the AFRICA Fund to rand used in international trade and help sustain the struggle through support other transaction limit its viability as an to the frontline states (High Commission international reserve currency, and, in of India, 2016). fact, presents an important reason for the In 1993, at the opening of a cultural rand to become part of a BRICS currency centre and consulate in Johannesburg and/or payment mechanism for trade formal relations between South Africa and/or other international transactions. and India was restored. Join Ministerial commission was established by India and Bilateral trade South Africa in 1994 in order to identify transactions between areas of mutual benefi cial cooperation. South Africa and Th ree agreements on custom cooperation, BRICS economies science and technology and visa free travel for diplomatic passport holders were signed during the commission seven South Africa has a large economy session that was held in 2008 in Pretoria in Africa and joining BRICS boosted its (High Commission of India, 2016). geopolitical signifi cance. South Africa Bilateral engagements between South is endowed with abundant minerals Africa and India have been extended and natural resources and some sectors in many ways. In 2010, memorandum are well developed unlike other African of understanding on cooperation in countries, these sectors include energy, the fi elds of agriculture, air services, transport sectors, fi nancial sectors and diplomatic academics was signed. and etc. South Africa’s endowment of President Zuma’s visit to India in 2010 natural resources and mineral resource led to the recovery of negotiations on complements BRICS countries such preferential trade area between India as Brazil’s specialisation in agriculture and Southern African Customs Union and raw materials, Russia as a major (Sidiropolous, 2011). player specialising in agriculture and Th e bilateral trade between South raw materials, Russia’s position as a role Africa and India shows that during player in the commodity market, India’s the GFC, the value of SA trade with 103 services exporting economy and China’s India dipped and has recovered in the USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

7,000,000 6,000,000 5,000,000 4,000,000 3,000,000 2,000,000 1,000,000

200420052006 2007 2008 2009 2010 2011 2012 2013 2014 2015 India`s exports to SA SA`s exports to India

Figure 3. Values of South Africa’s exports to India and India’s export to South Africa, US dollars Source: ITC calculations based on UN COMTRADE statistics

post-crisis period (Figure 3). Notably, Ranbaxy and CIPLA); and IT companies. South Africa’s exports (goods) to India Th ere is also Indian investment in South recovered even though India’s exports Africa’s mining sector (Ministry of (goods) to South Africa were reaching External Aff airs, 2013). SA’s exports to India. Below Figure 4 shows the values In the past India has been SA’s most of South African imports from India important export destination, as India’s and India’s imports from South Africa. strong demand for gold as a major product Since 2004 India’s exports from South (Alves, 2009). China overtook India as a Africa were below 4 million US dollars result of its strong demand for primary and in 2008, imports started to increase. resources connected to the expansion of Th e increase was largely due to South the Chinese economy and South Africa’s Africa’s rapidly growing demand for its exports to China grew progressively since pharmaceutical products and decrease the late 2000s. in 2009 due to the global fi nancial crisis Between 2013 and 2014, the Export- (Onyikwena, Taiwo and Uneze, 2014). Import Bank of India reported that Th e balance of trade between South South Africa had a share of 3.5% as an Africa and India is largely in favour of export destination of pharmaceuticals (Exim, 2014). A major growth area India with Indian exports to South Africa is pharmaceuticals. In 2013/2014 the much higher. Export-Import Bank of India repor- Bilateral trade between South Africa ted that South Africa had a share of and India increased by 135% between 3.5% as an export destination for phar- 2007/08 and 2011/12 and Indian maceuticals. Nineteen Major Indian companies have invested USD 328.25 investors in South Africa include million in South Africa for the period Tata (automobiles, IT, hospitality and of 2008–12 (Campbell, 2013). In 2016, ferrochrome products); the United South Africa and India signed the Breweries Group (breweries, hotels); memorandum of understanding and the 104 Mahindra (automobiles); a number of focus areas include the establishment pharmaceutical companies (including of innovation in the area of science and TOWARDS NATIONAL CURRENCY USAGE IN INTERNATIONAL TRANSACTION SETTLEMENTS...

16, 000, 000 14, 000, 000 12, 000, 000 10, 000, 000 8, 000, 000 6, 000, 000 4, 000, 000 2, 000, 000

200420052006 2007 2008 2009 2010 2011 2012 2013 2014 2015 SA`s imports from India India`s imports from SA Figure 4. Values of South Africa imports from India and India’s imports from South Africa, US dollars Source: ITC calculations based on UN COMTRADE statistics, 2016 technology, tourism and program of Zuma and Prime Minister Modi (2016) cultural cooperation (Kilian, 2016). further refl ected on the huge potential President Zuma and Prime Minister to increase bilateral trade and to expand Modi discussed the historical relations investment and agreed that both that the two countries share as well as the countries should examine obstacles mutual struggle against colonialism and to the promotion of mutual trade and oppression which has served to forge a investment. Th e leaders underlined the strong bond that is further underpinned importance of strengthening cooperation by a shared worldview (Ministry of between business entities of South External Aff airs, 2016). President Zuma Africa and India. Th ey identifi ed focus and Prime Minister Modi expressed areas for deeper cooperation including satisfaction with the current status manufacturing, mines and minerals, of bilateral relations. However they information technology, renewable emphasised that there is still scope for energy, pharmaceuticals, tourism and the further strengthening and deepening fi nancial services. Both leaders invited of relations in the political, economic, private sectors to invest in both countries. scientifi c and socio-cultural spheres and According to Kilian (2016), President it was agreed that frequent and sustained Zuma indicated that both countries contact between South Africa and India set a target of advancing bilateral in mutually identifi ed areas will serve to trade to 18 billion US dollars by 2018. maintain the momentum of the bilateral Th ese targets can be achieved if private relationship (Ministry of External Aff airs, sector commitments increase while 2016). the government focuses on resolving In the discussion, it was mentioned that barriers and address constraints related there is a need to intensify collaboration in to infrastructure and trade. the sectors such as defense, energy, agro- Data from the Indian government and processing, human resource development, the African Development Bank show that infrastructure development, science plus bilateral trade between India and Africa 105 technology and innovation. President rose from 1 billion US dollars in 1995 to USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

14, 000, 000

12, 000, 000

10, 000, 000

8, 000, 000

6, 000, 000

4, 000, 000

2, 000, 000

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Exports from SA Exports from SA Exports from SA to Brazil to Russia to China

Figure 5. Export from South Africa to Brazil, Russia and China, US dollars Source: ITC calculations based on UN COMTRADE statistics 2016

USD 75 billion in 2015. From 2010 to Africa increased from ZAR 29 billion in 2015, Nigeria was India’s largest trading 2011 to ZAR 54 billion in 2015, while partner in Africa with 1.6 billion US South Africa’s exports to India increased dollars export-import volume, followed from ZAR 24 billion in 2011 to ZAR 41 by South Africa with 1.1 billion US dollars, billion in 2015 (Kilian, 2016). while Kenya came third and Mozambique South Africa is pleased with this fourth (Rao and Kuwonu, 2016). A tight positive relationship with India as both bilateral trade relationship between countries benefi t from this bilateral trade. India and South Africa is visible on the Both countries value the importance continent with Tata Africa Holding being of their bilateral relationship and a highly recognizable Indian company in multilateral engagements through the Johannesburg (Rao and Kuwonu, 2016). BRICS engagements. To improve trade Its vehicles, including trucks, semi-trucks relationships between South and India and public transportation buses, branded challenges that impede the ease of doing with its red-and-white logos, are common business that are faced in both countries on African roads. must fi rst be addressed. Modi (2016) argued that more than In general the major export partners 150 Indian companies were currently of South Africa are China, United States, operating in South Africa, and both European economy, India, Zimbabwe, countries had to look at techniques to Namibia, Botswana, Mozambique (Work- expand this trade basket. man, 2017). Figure 5 shows that despite In 2015, trade between India and the debilitating eff ects of the the fi nancial South Africa reached ZAR 95 billion crisis on international trade among and trade with India represented 4.9% BRICS economies, South Africa’s trade 106 of South African imports and 4.1% with China remained relatively high. of exports. South Africa’s trade statistics During the global fi nancial crisis in 2008 also showed that India’s exports to South export growth for South Africa with TOWARDS NATIONAL CURRENCY USAGE IN INTERNATIONAL TRANSACTION SETTLEMENTS...

China fell slightly and rose again in 2010. measure that can be used to assess the However for the rest of BRICS countries degree of intra-BRICS international export growth with South Africa has been economic integration. falling since 2012 until 2015. Measuring the degree of BRICS References multi-lateral international economic integration however, requires a more nuanced network systems approach than 1. Alves P. India and South Africa: a linear bilateral measure of indicators Shift ing priorities // South African that do not show how integrated the Journal of International Aff airs. 2009. group is as a whole. Kali and Reyes Vol. 14. P. 86–109. (2007) have developed an IEI systems 2. Annual Report on Exchange approach to examine the extent of global Arrangements and Exchange Restrictions integration of a multilateral network. Th e // IMF. 2014. September. approach may be applied to the BRICS as 3. Asset management in South Africa. it measures the network density ratio of all possible links and relationships that are Ten things to know // Norton Rose in the group, and reveals the proportion Fulbright. 2014. September 8. URL: of multilateral relationships relative to http://www.nortonrosefulbright.com/ bilateral relationships. files/asset-management-ten-things-to- Ideally, in a globalized network, the know-120505.pdf share of multilateral relations relative to 4. Forex rates in South Africa // bilateral ones should be higher than in Bidvest Bank Limited. URL: http://www. a balkanized network. In other words, bidvestbank.co.za/business-banking/ the sum of the whole of intra-BRICS forex-services/retail-foreign-exchange- IEI should be greater than the sum of its rates.aspx parts. Th e extent of multilateralism can be seen through the property of network 5. Galvão M. Brazil, Russia, India and transitivity, sometimes called clustering, China: brand BRIC brings change. 2013. and measures the probability that ‘the 6. Genberg H. Currency interna- partner of my partner is also my partner’. tionalization: analytical and policy issues Th e measure provides insight into what // Hong Kong Institute for Monetary is referred to as the "neighborhood" Research Working Paper. 2009. No. 31. structure of the network. Transitivity 7. India-Africa: South-South Trade in the network means the presence of a heightened number of complex and Investment for Development // relationships and subnetworks each of Confederation of Indian Industry & which is connected to the others in the World Trade Organisation. 2013. system as a whole. Th e measure uses 8. India-South Africa Joint Statement trade statistics to show the structure and during the visit of Prime Minister to evolution of global trade for the number South Africa (July 08, 2016) // Ministry of actual and potential trading partners. of External Aff airs. Government of India. It can also show the structure of regional 2016. July 08. URL: http://www.mea.gov. trading, and the infl uence of individual in/bilateral-docu-ments.htm?dtl/27001/ countries and groups in a multilateral IndiaSouth_Africa_Joint_Statement_ network. Th e HSRC BRICS Research during_the_visit_of_Prime_Minister_ Centre is currently adapting the Kali and Reyes (2007) IEI model for application to to_South_Africa_July_08_2016 BRICS multilateral trade and economic 9. India South Africa Relations // High 107 relationships. Th e idea is to develop a Commission of India. 2016. February. USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

URL: http://www.hcisouthafrica.in/hc. J. Eatwell (eds.). L.: Macmillan, 1992. php?id=India-SA P. 754–757. 10. Inward Listings // Bravura. 19. Tavlas G. S., Ozeki Y. Th e Inter- URL: http://www.bravura.net/ service/ nationalization of Currencies: An inward-listings/ Appraisal of the Japanese Yen // IMF. Occasional Paper. 1992. No. 90. 11. Jianhua G., Zongxin Q., Chao Z., Jiarui Z. Th e Eff ect of Changes in the 20. Workman D. Top South African U.S. Monetary Policy on China’s Capital Trading Partners // World’s Top Exports. Market Stability and Trade between China URL: http://www.worldstopexports.com/ top-south-african-import-partners/ and Korea // International Monetary Review. 2016. Vol. 3. No. 2. P. 14–51. 12. Kali R., Reyes J. Th e Architecture of Globalization: A Network Approach to International Economic Intgration // Journal of International Business Studies. 2007. Vol. 38. No. 4. P. 595–620. 13. Kilian A. South Africa, India boast ‘enormous’ bilateral trade, invest- ment potential — Zuma // Engineering News. 2016. July 8. URL: http:// www.engineeringnews.co.za/ article/south-africa-india-boast- Appendix enormous-bilateral-trade-investment- potential-zuma-2016-07-08/ Weights for Rand Currency Basket rep_id:4136 Country/Area Revised weight 14. Lucey A., Makokera C. G. Deepe- ning South Africa–India private-sector Euro area 34.82 relations // Institute for Security studies. United States 14.88 ISS Paper. 2015. No. 284. China 12.49 15. Onyekwena C., Taiwo O., Uneze E. United Kingdom 10.71 South Africa in BRICS: a Bilateral Trade Analysis // South African Institute of Japan 10.12 International Aff airs. 2014. Occasional Switzerland 2.83 paper. No. 181. Australia 2.04 16. Rao P., Kuwonu F. India, Africa Sweden 1.99 rekindle trade ties // Africa Renewal. 2016. India 2.01 November. URL: http://www.un.org/ Republic of Korea 1.96 africarenewal/magazine/august-2016/ China, 1.48 india-africa-rekindle-trade-ties Hong Kong SAR 17. Sidiropoulos E. India and South Singapore 1.40 Africa as partners for development in Brazil 1.37 Africa? // Chatham House. Briefi ng Israel 1.11 Paper. 2011. March. Zambia 0.80 18. Tavlas G. S. Vehicle Currencies // 108 Canada - Th e New Palgrave Dictionary of Money and Finance / P. Newman, M. Milgate, Total 100 CONCLUSION

Conclusion

BRICS experience shows that as lift ed restrictions on capital transactions economic development of its member by non-residents. However, as can be seen countries progressed, prerequisites for through the experience of South Africa their local currencies’ internationalization (which has the most developed stock were being formed. Th e GFC once again market among the BRICS countries), revealed the instability of a monetary investment demand alone does not suffi ce system based on the US dollar and caused for ensuring signifi cant use of a national an interest in wider usage of BRICS currency in international settlements. national currencies for this purpose as In summary, the BRICS countries its member countries (except for South experience allows us to contend that only Africa)1 entered the top ten of the world’s a well-balanced economic development largest economies with a total GDP ensuring an equal implementation exceeding one trillion US dollars. of all the prerequisites necessary for However, this idea didn’t gain an internationalization of national substantial support, as the share of the currencies, will provide a solid basis BRICS countries in world trade has for a substantial increase in their use in increased at a slower pace, compared international settlements. At the same with high growth rates demonstrated by time, a requirement of meeting the set national economies. China is the only of preconditions does not preclude BRICS country in the top ten in terms governments from implementing of of exports (1st place with 2.3 trillion a more active policy aimed both at US dollars or 14.02% in 2015). By the creation of such conditions and removal end of 2015, Russia took 15th place of existing administrative barriers that (2.11%), India — 19th place (1.62%), impede a wider use of national currencies Brazil — 24th place (1.17%) and South in cross-border settlements. Africa — 37th place (0.5%)2. In this However, practical steps in this di- context, monetary authorities of several rection primarily depend on the BRICS countries preferred to encourage interest of BRICS monetary authorities their national exporters for receiving in promoting their currencies on the revenue denominated mainly in US dollars or euros. Th is intention was also global market. More work is required based on a predominance of resource- to convince politicians and policy based commodity exports priced makers that it is a useful goal to pursue. primarily in US dollars. Nonetheless, the only way BRICS nations Hence, a demand for the currencies of can challenge the existing international most BRICS countries on international monetary order is through coordination. markets was relatively insignifi cant. Th e BRICS fi nancial regulatory bodies Moreover, only Russia and South Africa and central banks could be tasked to gauge the feasibility of policy coordination and 1 Back then, South Africa was the largest build consensus towards this goal. economy in Africa competing for this place with Th e authors of the study consider Nigeria. that following steps could be taken 2 See UN Comtrade Database // United 109 Nations Statistics Division. URL: http:// comtrade. initially on this issue. Firstly, it seems un.org/data appropriate to focus joint eff orts on pro- USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

viding companies engaged in foreign bond markets of their local currencies trade from BRICS countries with the are all less developed. Th ough China same, or lower transaction (compliance) and Russia boast huge foreign exchange costs, guarantees of settlement and risk reserves, most of these reserves are management that they currently have in invested in the sovereign bonds of the utilizing the dollar, euro or yen. To achieve western developed countries. Th is led to this goal it will be necessary to encourage currency and maturity mismatching in trading directly in BRICS currencies that national fi nancial systems. If eff orts can will signifi cantly contribute to lowering be made to develop the bond markets of costs. At the time direct trading is their local currencies and enhance the available only for "RUB/CNY" and "CNY/ investment and fi nancing functions of RND" currency pairs. However, it could these markets, BRICS will signifi cantly be further enriched in the near future reduce their excessive dependence not with currency pairs characterized by only on banks or international capital signifi cant volumes of bilateral trade. Th is for fi nancing but also on dollar assets for step has to be augmented with creation outbound fi nancial investment. and use of hedging instruments in BRICS Th e development of local currencies currency pairs which might allow to bond markets contributes both to reduce risk management costs. During BRICS economic advancement and the the fi rst stage leading public banks of internationalization of their currencies. If BRICS countries may function as market there are high-capacity bond markets, makers on currency pairs to provide non-residents will be confident of necessary liquidity. opportunity for unrestricted placing Widening of Swap Agreements is their funds in BRICS currencies. also of signifi cant interest for foreign This will additionally heighten the exchange. Th ough the BRICS countries interest for making settlements in have established a Contingent Reserve these currencies. Furthermore, this Arrangement, this arrangement aims to would meet collateral criteria required maintain fi nancial stability by providing for a currency to function as a store of short-term liquidity support when value for other countries. Strengthening member countries face international BRICS local bond markets also will spur payment pressure. Meanwhile, the cross-border investments made in local currency swap under this arrangement currencies. Th is might redress foreign is one between US dollar and local trade imbalances (at least in part) among currencies of BRICS, not one among the BRICS countries. Th e principles of such BRICS currencies. Currently, there are mechanism are presented in Figure 1. few local currency swap agreements in Joint eff orts to provide interconnected force (between Russia and China, China development of BRICS bond markets and the South Africa). Th is could be the growth would require coordinated capital occasion to ensure greater stability to account liberalization amongst the BRICS BRICS FX markets. For instance, central countries. Th is involves, fi rst and foremost, banks may utilize swap agreements to countries having substantial trade surplus anchor expectations in this fl edgling with other partners and consequently market and limit worries of liquidity risk. enjoying the opportunity to accumulate Another avenue of cooperation could substantial surplus on currency balances. be the development of bond markets. Th e majority of BRICS countries have an BRICS have relied heavily on banks (such experience of issuing such bonds (Indian 110 as China and Russia) or international "masala bonds", Chinese "dim sum bonds", capital (such as India and Brazil) for etc.) on Western markets or in Japan (South boosting economic growth while the Africa). It seems appropriate to attract CONCLUSION

FX market Country B Country A currency purchase (500 million), currency purchase (500 million), own currency selling (500 million) own currency selling (500 million)

Payments for goods (in the amount of 500 million)

BRICS country A Foreign trade BRICS country В

Payments for goods (in the amount of 300 million)

Revenue (200 million) Investments in bonds (200 million)

Bond market

Figure 1. BRICS internal interaction scheme. Note: currency exchange rates are conditionally assumed at 1:1 Alternative bond placement options: а) A company from country А places bonds denominated in the country A currency on the country A market. Investors from country B (fi nancial institutions, primarily) are allowed to acquire them; b) A company from country А places bonds denominated in the country A currency on the country B market. Investors from country B (institutional investors, primarily) are allowed to acquire them. Th e revenue received can be freely repatriated to the country А; c) A company from country А places bonds denominated in the country B currency on the country B market. Th e revenue received can be freely repatriated to the country А their emissions to BRICS stock exchanges. risk and yield of bonds is a fundamental Th is would increase competitive ability of factor. In this regard, the rating of credit national investment banks responsible for rating agencies will directly defi ne placement of securities. both whether the bond issuance would Along with that, investors from the be successful, and the cost of bond BRICS countries (institutional investors, fi nancing. International credit rating fi rst of all) should have an opportunity agencies’ activity causes fair criticism to buy bonds that are being traded in from developing countries. Th ere are any other BRICS country. What is more, many examples of politically driven foreign companies should be allowed decisions concerned with their credit to place bonds denominated in BRICS rating assessments. However, it is these currencies in the internal BRICS markets. ratings that foreign investors take into At the time China only provides non- account, and this can hardly be changed residents with such an opportunity (so- in the near future even if the BRICS called "panda bonds"). joint rating agency is launched. Within For investors, the attraction of local- this framework, the use of guarantee- currency bond markets is determined based mechanism looks promising, as 111 by multiple factors. Among them, the it contributes to upgrade ratings of the USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

BRICS companies’ bonds. In this regard, contributing to enhancing LCY use in it is worth learning from the experience settlements in the BRICS countries. of the European Investment Bank and its Within BRICS, China and India are major subsidiary European Investment Fund. importers of raw materials while Russia It also could be advisable for the BRICS and Brazil are major exporters of raw countries to set up investment funds with materials. Th is fact could help connect local currencies (operated by the New supply and demand among BRICS Development Bank, for instance), with countries. Consequently, raw material their investment direction and business trade could be mediated by setting market mode designed according to the actual prices denominated in local currencies. demand of each BRICS country. With appreciable quantity of foreign Such practices are already being investors trading on the exchange, this will developed, marking a moving-off in the lead to internationalization of contracts specifi ed direction. In June 2017 BRICS denominated in local currencies. Ministers of Finance agreed to set up a It is also important to study the views common sovereign bond Fund totaling of entities engaged in foreign economic USD 10 billion in order to support the aff airs for a further promotion of the BRICS debt markets. Th is was confi rmed BRICS currencies on the global market. at the ninth BRICS Summit held in Such studies have been carried out by September: in the Xiamen Declaration certain ASEAN and EU countries. Th ese leaders of the BRICS countries agreed surveys help to identify factors aff ecting "to promote the development of BRICS a choice of the invoicing and payment Local Currency Bond Markets and jointly currency and contribute to revealing the establish a BRICS Local Currency Bond remaining administrative barriers and Fund, as a means of contribution to the other issues that companies may face capital sustainability of fi nancing in when using national currencies in their BRICS countries..."3. settlements. Data obtained from the Th e development of an exchange aforementioned studies assists to clarify market and the building of a common practical steps proposed in this study. BRICS bond market will require wide- For instance, it allows to determine both ning of cross-border interbank con- the FX and fi nancial market instruments nections. Within this framework it which business may need. would be benefi cial for the BRICS Along with the above-mentioned countries to strengthen interbank market fi elds of cooperation shared by all study cooperation through setting an effi cient authors a number of particular proposals BRICS cross-border clearing settlement were also made by individual research system (probably, establishing a special participants. company modeled aft er Euroclear) and improving compatibility among national Brazil accounting and auditing standards as well as related laws and regulations through Brazillian experts advocate for consultation. creating an intra-BRICS joint payment Launching of a Commodity Exchange system based on the SML principles. or some type of an e-trading platform for Companies integrated to supply chains trade in goods and derivatives of various within BRICS could be fi rst to drive a kinds can be one more instrument pilot implementation of this system. Granting to companies the right to 3 See BRICS Leaders Xiamen Declaration use a currency which is most suitable for 112 // BRICS 2017 China. 2017. September 4. URL: http://brics2017.org/English/Documents/ them (including US dollar) is regarded Summit/201709/t20170908_2021.html as an essential condition for putting this CONCLUSION initiative into practice. Further widening the lack of capital account convertibility the practice of using national currencies of BRICS currencies in the coming years. in international settlements is associated Th erefore as a fi rst step, BRICS with providing users of the payment countries could follow the Hong Kong system with additional incentives from example and pilot such a scheme as government, including tax benefi ts. a fi nancial special economic zone or international fi nancial center where Russia capital controls are relaxed. Th e SEZ/IFC based approach seems to be the best way Experts from the Russian Institute to proceed as it allows countries to move for Strategic Studies propose to reach towards capital account openness at their a common understanding within the own pace while permitting quick market BRICS on an issue whether the currency development with limited downside of exporter or importer will be accepted risk. Joint development of fi nancial as an invoicing currency. When that SEZs/IFCs for the purposes of currency issue is solved it will greatly simplify internationalization in the BRICS a development of instruments aimed countries also provides an opportunity at encouraging settlements in national to additionally pilot a unifi ed regulatory currencies. framework that could be matched to Using the importer’s currency has global standards to enable fi rms to easily certain benefi ts but also creates additional adopt the new LCY settlement and risk risks. First of all, it requires ensuring management. eff ective absorption of a national currency amount that remains abroad. Otherwise its massive exchange may have China a destabilizing eff ect on the FX market and lead to a multiple depreciation. Experts from the Institute of World Within this framework, the most Economics and Politics, the Chinese suitable principle is that the price Academy of Social Sciences are of of foreign trade contracts should be opinion that establishing the BRICS established in the exporter’s currency. cross-border interbank payment system Risks of accumulating local currency on the basis of Blockchain technology balances in this case are mitigated to a might be a key step of BRICS cross-border certain extent as the volume of exports fi nancial infrastructural construction. limits the demand for foreign exchange. Such infrastructure would not only Taking into account dependence of export signifi cantly improve the effi ciency of revenues from extractive industries cross-border interbank payment among (Brazil, Russia, South Africa), one more the BRICS countries but also exert a necessary condition for a large-scale shift fundamental impact on the international of the BRICS countries to settlements monetary and fi nancial system. in their national currencies is exports Given that Blockchain is safe, trans- diversifi cation. parent, distributed and tamper resistant, the trust model between fi nancial systems India would no longer rely on intermediation and many banks will establish Experts from National Institute of "decentralized" ties and realize real-time Public Finance and Policy, New Delhi, digital transactions. Th e removal of the take the view that it may not be feasible to intermediary link of the third-party 113 enhance LCY use on a large scale due to fi nancial institution means cross-border USE OF NATIONAL CURRENCIES IN INTERNATIONAL SETTLEMENTS. EXPERIENCE OF THE BRICS COUNTRIES

payment will no longer depend on such systems as SWIFT and CHIPS. South Africa

Experts from Nelson Mandela Metropolitan University and Th e BRICS Research Center, Human Sciences Research Council agree that exploring the feasibility of a common payment mechanism in and amongst the BRICS countries is important. Th is will not only start a long way to consolidating intra-BRICS trade and investment rela- tions, but also promote a more balanced multilateral trade, investment and international fi nancial regime from which other emerging and developing economies may benefi t. As a long-run objective adopting a BRICS single currency could be regarded. Th is would take integration a step further towards much closer economic alliance. Consequently, it demands extensive preparations — economic and legal con- vergence. In that regard this research could be seen as a starting point for a multilateral project which will draw upon expertise from various fronts including political, legal, central banks, fi nancial and other relevant institutions.

114