Vijay Kumar Gaba

Early this year BRICS, a bloc of leading emerging economies, announced the induction of five new members, viz., Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates, to its fold. The ten-member bloc has a significant presence in global trade. More specifically, it exercises significant control over the global energy markets, controlling 42% of global oil production and 35% of total oil consumption.

In July 2023, the then President of BRICS, South Africa claimed that over 50 emerging nations have expressed their desire to join the group. Recently, Russia’s Federation Council Committee on International Affairs, stated that BRICS would be expanded further as more than 40 countries are desirous of joining the group.

The cooperation between BRICS members is free, and flexible and extends to a variety of subjects of common interest amongst members. The members and other countries desirous of joining the group, view BRICS as an alternative to global bodies viewed as dominated by the traditional Western powers and hope membership will unlock benefits including development finance, and increased trade and investment.

Defining the vision of BRICS, President Putin said, “BRICS is attracting an ever increasing number of supporters and like-minded countries that share its underlying principles such as sovereign equality, openness, consensus, aspiration to form a multi-polar international order and a fair global financial and trading system.

The expansion and strengthening of BRICS could, therefore, be interpreted from different perspectives. From the geopolitical perspective, it could be seen as a vote of no-confidence in the extant global order, dominated by Western developed countries (especially the US), by the emerging economies. A larger BRICS could undermine the dominance of NATO, the UN, and even the IMF.

From India’s perspective, it could act as a strong resistance to any material escalation between India and China. We have already seen the traditional rivals Iran and Saudi Arabia bridging the differences and coming together on the Palestine issue. We have also witnessed ineffectiveness of the NATO sanctions against Russia over the Ukraine invasion issue. BRICS and other developing countries have increased their trade with Russia materially in the past couple of years, as reflected in a larger current account surplus for Russia.

From an economic perspective, a larger and stronger BRICS could play a significant role in determining the terms of global trade. Its present and prospective members would control a significant proportion of the global human, mineral, and manufacturing resources. Besides, helping in securing better terms of trade, ensuring energy security is seen as another key advantage of a stronger and larger BRICS.

From a financial perspective, post global financial crisis, a large number of developing countries have reported a slowdown in financial aid from developing countries. The conditions appear to have deteriorated further post the Covid-19 pandemic. A deeper and wider cooperation between the enlarged BRICS grouping, the humanitarian aid to the developing nations could be restored.

From a monetary perspective, there is an intense debate about limiting the role of USD in global trade. A BRICS agreement on adopting a common independent currency or increasing the bilateral trade in local currencies could help in achieving this objective. There is strong evidence of a material rise in yen trade between Saudi Arabia-China and Russia and China. India has also made some advances in promoting INR trade with traditional trade partners like UAE and Russia. We might see more developments on this front in the next couple of decades.

These may be the early days to term BRICS as a foundation for change in the post-USSR unipolar global order to a multipolar world order that shall facilitate much-delayed reforms in the global institutions like the UN and IMF etc. Nonetheless, the developments are encouraging and offer hope.

Wishing all the readers, family, and friends a very Happy Diwali. May the Lord enlighten all of us and relieve everyone from pain and misery. 

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The growth is slowing across the world. The engines of global growth - India and China – are also expected to slow down in 2024. Most European countries are flirting with recession. Canada is technically in recession. The US growth is stronger than estimates but not enough to support the

Growth decelerating

As per the latest World Economic Outlook report released by the World Bank, global growth has slowed down to 3% in 2023 from 3.5% recorded in the year 2022. The global economic growth is expected to further decelerate to 2.9% in 2024. The advanced economies have grown by 1.5% in 2023 against 2.6% in 2022. Their growth is likely to further decelerate to 1.4% in 2024. Economic growth in Emerging economies is also not accelerating. These economies are expected to grow at the rate of 4% in 2023 and 2024, against 4.1% in 2022.

Though the likelihood of a hard landing in the US may have receded, the risks to the growth still remain tilted to the downside.

Inflation persisting

The growth slowdown could be largely attributed to the effects of the monetary tightening measures taken since 2022. However, despite the sharp growth deceleration, global inflation is likely to stay above 5% in 2024 also. The World Bank expects global inflation to ease to 6.9% in 2023 and 5.8% in 2024, against 8.7% in 2022. In recent weeks, the inflationary expectations have risen again and could contribute—along with tight labor markets––to core inflation pressures persisting and requiring higher policy rates than expected. More climate and geopolitical shocks could cause additional food and energy price spikes.

Geoeconomic fragmentation – risks rising for emerging economies

The rising geoeconomic fragmentation is seen as a key risk to global growth and financial stability. Intensifying geoeconomic fragmentation could constrain the flow of commodities across markets, causing additional price volatility and complicating the green transition. Amid rising debt service costs, more than half of low-income developing countries are in or at high risk of debt distress.

No room for policy error

Given the still high inflation, unsustainable fiscal conditions and high cost of disinflation, there is little margin for error on the policy front. Central banks need to restore price stability while using policy tools to relieve potential financial stress when needed. effective monetary policy frameworks and communication are vital for anchoring expectations and minimizing the output costs of disinflation. Fiscal policymakers should rebuild budgetary room for maneuver and withdraw untargeted measures while protecting the vulnerable.

However, if we juxtapose these economic realities with the market performance, the dissonance is too stark. Formulating an investment policy that balances the macroeconomic and market realities is extremely challenging under the current circumstances.

I shall share my thoughts on this after the Diwali break. I will post next on 17^th November.

The Reserve Bank of India constituted an Inter Departmental Group (IDG) in December 2021 “To examine issues related to Internationalisation of INR and suggest a way forward”. The Group submitted its recommendations in October 2022; and the same have been made public last week. The following are some of the highlights of the IDG recommendations.

Terms of References

The terms of reference of the IDG were as follows -

·         To review the extant framework for use of INR for current and capital account transactions and assess their current levels;

·         To review the extant position of use of INR for transactions between non-residents and the role of off-shore markets in this regard;

·         To propose measures, consistent with the desirable degree of capital account liberalization, to generate incentives for use of INR for trade and financial transaction invoicing and denomination, official reserves and vehicle currency for foreign exchange intervention after analyzing data obtained from AD Banks on INR invoiced trading;

·         To propose measures to bring greater stability in the exchange rate of INR determined by market forces and deep and liquid market with availability of wide range of hedging products, efficient banking system and world class infrastructure with easy accessibility to both residents and non-residents;

·         To recommend measures to address concerns, if any, arising of the Internationalisation of INR;

Internationalisation of currency

“An international currency is used and held beyond the borders of the issuing country for transactions between residents and non-residents, and between residents of two countries other than the issuing country. Currency Internationalisation has thus been described as the international extension of a national currency’s basic functions of serving as a unit of account, medium of exchange and store of value. In other words, the internationalization of a currency is an expression of its external credibility as the economy integrates globally.”

Why Internationalisation?

Internationalisation of a currency helps both the government as well as the private sector the issuing currency, by—

·         allowing a country’s government to finance part of its budget deficit by issuing domestic currency debt in international markets rather than issuing foreign currency instruments;

·         allowing a government to finance part, if not all, of its current account deficit without drawing down its official reserves;

·         allowing the country’s exporters and importers to limit exchange rate risk by allowing domestic firms to invoice and settle their exports/imports in their currency, thus shifting exchange rate risk to their foreign counterparts;

·         permitting domestic firms and financial institutions to access international financial markets without assuming exchange rate risk;

·         offering new profit opportunities to financial institutions, although this benefit may be offset in part by the entry of foreign financial institutions into the domestic financial market (to the extent that the government permits it); and

·         reducing the cost of capital and widening the set of financial institutions that are willing and able to provide capital; thus, boosting capital formation in the economy thereby increasing growth and reducing unemployment.

Cost of internationalisation

The internationalisation of a currency does not happen without a cost. Besides resulting in higher volatility in the exchange rates, it usually has monetary policy implications as the obligation of a country to supply its currency to meet the global demand may come in conflict with its domestic monetary policies, popularly known as the Triffin dilemma. Also, the internationalisation of a currency may accentuate an external shock, given the open channel of the flow of funds into and out of the country and from one currency to another.

The costs also emanate from the additional demand for money and also an increase in the volatility of the demand. International currency use can also have an undesirable impact on the financing conditions.

The process of internationalisation

The IDG felt that internationalisation of INR is a process rather than an event. A series of continuous efforts would be needed to achieve the long-term goal of INR internationalisation. There is a need to build upon the small steps already taken.

Many factors play a role in internationalisation of a currency. The prerequisite for internationalisation is however “widespread use of a currency outside the issuer’s borders”. To popularize the international use of a currency, the factors like size of the economy; centrality to global trade; capital account openness, macroeconomic stability, and depth of financial markets, which provide global investors with a safe store of value, etc. are considered important.

The roadmap for internationalisation therefore includes:

·         Removal of all restrictions on any entity, domestic or foreign, to buy or sell the country’s currency, whether in the spot or forward market.

·         Domestic firms can invoice some, if not all, of their exports in their country’s currency, and foreign firms are likewise able to invoice their exports in that country’s currency, whether to the country itself or to third countries.

·         Foreign firms, financial institutions, official institutions and individuals can hold the country’s currency and financial instruments/assets denominated in it, in amounts that they deem useful and prudent.

·         Not only are foreign firms and financial institutions able to issue marketable instruments in the local currency, but the issuing country’s resident entities are also able to issue local currency-denominated instruments in foreign markets.

·         International financial institutions, such as the World Bank and regional development banks, can issue debt instruments in a country’s market and use its currency in their financial operations.

Internationalisation of the INR and capital account convertibility are processes which are both closely and symbiotically intertwined with each other.

Recommendations of IDG

In view of the IDG over the long term (5yr and above), India will achieve higher level of trade linkages with other countries and improved macro-economic parameters, and INR may ascend to a level where it would be widely used and preferred by other economies as a “vehicle currency”. The IDG recommended that keeping in mind the long run goal of inclusion of INR in IMF’s SDR basket, the following measures should be taken in the short and medium term.

Short term (upto 2yrs) measures

·         Designing a template and adopting a standardized approach for examining the proposals on bilateral and multilateral trade arrangements for invoicing, settlement and payment in INR and local currencies.

·         Making efforts to enable INR as an additional settlement currency in existing multilateral mechanisms such as ACU.

·         Facilitating LCS framework for bilateral transactions in local currencies and operationalising bilateral swap arrangements with the counterpart countries in local currencies.

·         Encouraging opening of INR accounts for non-residents (other than nostro accounts of overseas banks) both in India and outside India.

·         Integrating Indian payment systems with other countries for cross-border transactions.

·         Strengthening financial markets by fostering a global 24x5 INR market and promoting India as the hub for INR transactions and price discovery.

·         Facilitating launch of BIS Investment Pools (BISIP) in INR and inclusion of G-Secs in global bond indices.

·         Recalibrating the FPI regime and rationalizing/harmonizing the extant Know Your Customer (KYC) guidelines.

·         Providing equitable incentives to exporters for INR trade settlement.

Medium-term measures (2 to 5yrs)

·         A review of taxes on Masala bonds.

·         International use of Real Time Gross Settlement (RTGS) for cross border trade transactions and inclusion of INR as a direct settlement currency in the Continuous Linked Settlement (CLS) system.

·         Examination of taxation issues in financial markets to harmonise tax regimes of India and other financial centers.

·         Allowing banking services in INR outside India through off-shore branches of Indian banks.

The IDG discussed in detail the steps already taken by the government and RBI to achieve the larger objective. From the recommendations however it appears that the steps already taken are too small. The government needs to accelerate the process to earn the confidence of domestic and international businesses and investors to improve the acceptability of INR over the next five years. The most important step seems to be “decontrol”; something the incumbent government has not been very fond of. The volatility, opacity and subjectivity in the policy making seems to have led to erosion of faith in INR. These are perhaps the factors which prevented IDG from categorically saying that INR could be internationalised in the next 10yr or so.

Also see: Internationalisation of INR - 1

The past few months have been quite trying for investors and traders in the financial and commodity markets. The markets have been jittery, and indecisive. Obviously, the market participants are becoming somber in their market outlook for the short term.

The global order is perhaps undergoing a major reset and the picture of emerging global order is incomplete. Consequently, the present global economic, geopolitical and financial conditions are quite uncertain and challenging.

As per the conventional wisdom, at this time the investors should be busy assessing the likely contours of the emerging global order, forecasting the investment opportunities and positioning themselves as per their assessments; whereas the traders should be deciphering the opportunities arising due to the transition. The shifting investors’ positioning may create opportunities for the traders in the markets.

I noted the following key trends in the markets to assess how the investors’ positioning is shifting and where traders are finding opportunities. However, I am not sure if the current market positionings are totally in consonance with the conventional wisdom. Maybe, it is early days in the transition; or the uncertainties are too much; or it’s a combination of both. Perhaps, we would know this with the benefit of hindsight only.

1.    After lagging the emerging markets for 15years, the developed markets have started to outperform in the past one year. Prima facie it may look like a case of rising risk aversion amongst global traders. But investors must be appreciating that the risk in developed markets is much more pronounced than the emerging markets. The central bankers may have exhausted the newly acquired monetary policy tools that supported the developed economies and consumers in the post Lehman era. Unwinding of unsustainable liquidity and debt may bring more developed economies to the brink than the emerging markets.

For example, in the past 5years most of the sovereign debt issued in the Euro area has been bought by the European Central Bank (ECB). The countries that infamously came to the brink during the global financial crisis (Spain, Italy, Greece etc.) have raised huge debt without demonstrating any sustainable improvement in their servicing capability. Now since the ECB is unwinding its bond buying program, next year over EUR250bn worth of sovereign debt will have to be sold to the private investors who may not be as obliging as ECB has been in the past 12years. Unsustainable debt at the time of rising rates would make these countries riskier than the emerging markets like China, India, Brazil, Korea etc.

Even the USA, is facing a stagflation like condition. Rising rates may make USD stronger and hurt the US exports, further pressurizing the growth.

2.    Most of the countries are struggling with inflation that is mostly a supply side phenomenon. However, instead of improving the global cooperation to ease the supply chain bottlenecks and stimulate investment in further capacity building, most countries have chosen to stifle the global cooperation and invest in local capacities. This will (i) prolong the present supply shortages and (ii) have far reaching implications for global trade and cooperation.

3.    Investors have not preferred the conventional safe havens like gold, CHF, US treasuries etc. in the past one year and the EM currencies have not sold out the way these used be in past instances of extreme risk aversion.

4.    Numerous experts are calling for commodity supercycle and persistent inflation. This is a clear case of mistrust in effectiveness of the central bankers, who have not only successfully averted two major disasters in the past 12years – first the global market freeze post Lehman collapse and secondly global lockdown post outbreak of pandemic. I find no reason to believe that they will fail in reining the inflation using monetary policy tools. In fact most commodity prices have shown signs of peaking after the US Fed's aggressive posturing on monetary tightening. Higher cost of carry, tighter margins and slower growth should kill the inflationary expectations in no time; particularly when most of the commodity demand could actually be speculative or in anticipation of future demand assuming the present tightness in supply to continue.

For record, the commodity heavy stock market of Brazil has been one of the worst performers in the past one month.

5.    The criticism of cryptocurrencies is weakening and their acceptance is rising by the day. Many harsh critics of cryptoes have softened their stand to conditional criticism. While the opposition to cryptoes use as currency is still strong, their role as store of value is gaining wider acceptance. Obviously, it will have implications for Gold and USD –the two most important conventional ‘store of value’ instruments.

6.    The global investors seem to be losing hope in China now. Till last year the valuation argument was very strong in favor of Chinese equities. No longer is the case. Despite 15yrs of no return, not many are arguing convincingly for Chinese equities now.

7.    The Free Trade Agreement (FTA) between the UK and India may be a positive consequence of Brexit for India. The FTA with Australia has also been signed. India has defended its bilateral trade relations with Russia despite immense global pressures in the wake of ongoing Russia-Ukraine war. Besides, the UN has not taken any significant measures to end the war.

It has to be seen whether we are entering an era of bilateralism at the expense of dissipation of multilateralism. If that be so, the role of the multilateral charters like WTO, UN, IMF etc. will have to be reassessed in the emerging global order. 

 In the aftermath of devastation that took place due to the second world war (WWII), some key global institutions were created and multilateral agreements signed to (i) avert chances of another major war; (ii) enhance global cooperation for accelerated reconstruction work; and (iii) promotion of globalization of trade and commerce to ensure equitable growth and development. Bretton Wood agreement signed in 1944 was one of such efforts.

The Bretton Woods agreement established the U.S. dollar as the reserve currency for world. The idea was to prevent competitive devaluations of currencies, avert trade wars and promote international economic cooperation for growth & development. The Bretton Wood signatories agreed to maintain fixed exchange rates between their respective currencies and the US Dollar. The US dollar in turn was pegged to the price of the gold.

Until WWI, most countries followed the gold standard for their respective currencies; which essentially meant that they promised to exchange their currencies for gold of equivalent value as per the current international prices of gold. This significantly constricted the flexibility in their monetary policy, as only a few countries had enough gold reserves to back their monetary requirements for development efforts needed in post war period. Abandoning the gold standard, they printed massive amount of money leading to hyperinflation, which eventually led to great depression and another great war.

Post WWII, most countries considered reverting to gold standard. However, since at that time, US had held more than three fourth of global gold reserves at that time, it was felt that making the gold pegged USD the reserve currency, instead of gold, would provide the necessary flexibility in monetary policy (since unlike gold, the USD supply could be flexible) to support growth and development.

The energy price led stagflation in US eventually led to the demise of Bretton Wood agreement. To get the US economy out of stagflation (no growth and high inflation) President Nixon sharply devalued the USD. Thus sharp devaluation led to a run on the US gold reserves, forcing the US to unpeg USD from gold prices and thus violating the Bretton Wood Agreement. The gold peg ended in 1971 but USD continued to remain the reserve currency of the world in absence of a viable alternative.

Last week, Kristalina Georgieva, IMF Managing Director, in her speech called for a new Bretton Wood Moment for the world (see here). Comparing the damage to the global economy caused by Covid-19 pandemic, she emphasized on the greater need for global cooperation to put the global economy back on growth path. She said, “Today we face a new Bretton Woods “moment.” A pandemic that has already cost more than a million lives. An economic calamity that will make the world economy 4.4 % smaller this year and strip an estimated $11 trillion of output by next year. And untold human desperation in the face of huge disruption and rising poverty for the first time in decades. Once again, we face two massive tasks: to fight the crisis today — and build a better tomorrow.”

She further adeed, “We face what I have called a Long Ascent for the global economy: a climb that will be difficult, uneven, uncertain—and prone to setbacks.

But it is a climb up. And we will have a chance to address some persistent problems — low productivity, slow growth, high inequalities, a looming climate crisis. We can do better than build back the pre-pandemic world – we can build forward to a world that is more resilient, sustainable, and inclusive. We must seize this new Bretton Woods moment.”

She specifically called for “Prudent macroeconomic policies and strong institutions”, “people centric policies” and “climate change” as three imperatives for the new system.

Obviously, the emphasis is on greater global cooperation, sustainability and equality. Unfortunately, a number of analysts, traders and strategists have read her comment to mean return of gold standard.

Neils Christensen, quoted some of the popular comments in his blog post (see here) highlighting how the people are misreading her comments for a BULL call on gold—

“Gold is on its way back to monetary policy in a direct way. The IMF last week confirmed they WILL NOT sell gold reserves. Now they are calling for a new Bretton Woods arrangement. WELCOME TO THE ERA OF GOLD ? — Gold Telegraph

Imf calls for a new Bretton Woods. A new gold standard. Sit tight. Evidence is piling. — Gold Ventures

IT'S OFFICIAL IMF CALLS FOR 'A NEW BRETTON WOODS' 'A New Bretton Woods Moment'— Willem Middelkoop

A New Financial System Backed By Gold. It Will Never Happen You All Said Bretton Woods Was A Gold Backed Monetary System. The Best Is Yet To Come? Baba & Riddlers”

In my view, a new global order will definitely emerge out of this pandemic. The new order will address sustainability and equity issues. Gold will not be a key component of the new order. USD may retain its dominance but it shall face serious challenge from other currencies, including the digital currencies.