Structure Introduction & Background Single Currency Theoretical - PowerPoint PPT Presentation

Exploring the use of a common currency and/or payment mechanism amongst BRICS countries Jaya Josie, Head, BRICS Research Centre, HSRC , Ronney Ncwadi, Head , Department of Economics, NMMU & Babalwa Siswana, Researcher, BRICS Research Centre, HSRC

Structure  Introduction & Background  Single Currency Theoretical Arguments  Intra-BRICS trade  Rationale for Single Currency/Payment Mechanism in BRICS economies  Economic performance trends in BRICS economies  Data analysis and procedures  Vector Auto-Regression Analysis  Conclusion

Introduction • Paper draws on joint study “Pre -conditions and Possibilities for using National BRICS Currencies in International Settlements “ led by the RISS • Current Debates: Does Brazil, Russia & SA’s (BRS) slow economic recovery from the GFC presage the imminent demise of BRICS? • International trade, investment & finance trends in BRS & BRICS severely affected by exchange rate volatility • BRICS countries represents two thirds of the share of developing world economy  This share increased from 8% in 2002 to 22.2% in 2015 • To to mitigate GFC effects BRICS countries established NDB  Launched in 2014  Initial fund of US$100 billion • NDB set up by BRICS plans to provide lending to technology innovation projects • In 2016, NDB approved $1.5 billion loans to BRICS member states • Considering BRICS Rating Agency

Background • Joint study examines in general common BRICS payment mechanisms to reduce dependence on US $ and Forex. • This paper focuses on theory of using a common currency for BRICS • Example: the Euro in the European Union (January 1999) • Other common mechanisms include  Bilateral or multilateral Swap Arrangement for trade & investment  Use of the BRICS Contingency Reserve Agreement (CRA) as Special Drawing Rights (SDR) to cushion against external shocks  Pegging BRICS currencies to a gold standard  Use of one BRICS international reserve currency (e.g. RMB) for payments • Among BRICS countries, Chinese Renminbi (Yuan) has attained international reserve currency status • A Multilateral approach ensures investment toward full employment (Kalecki, 1946) as interconnected economies reduce disputes through negotiation • Aim: to test if convergence of BRICS currencies towards a single currency is a necessary condition for greater multilateral economic integration among BRICS

International Reserve Currencies in Transactions • Trade relations & trade rivalries are dominated and determined by Dollar, Euro, Pound sterling & Yen among developing and emerging countries Figure 1: IMF weight of Renminbi among SDR reserves currencies • Trade & Investment in BRICS is in the forefront in boosting economic growth and sustainable development

Rationale for Single Currency/Payment Mechanism in BRICS economies • International finance is failing to keep pace with dynamic changes in the developing countries • Explore possible common currency/payment systems in & among BRICS countries (e.g. financial cooperation between China & Russia) becaue it;  Increases price transparency as prices in different currencies can be difficult to compare  Increases inward investment

Current State of Trade & Investment in BRICS • Greater emphasis on trade in goods than on services • China is dominant in industrial production • Russia & SA mainly mineral resources & oil • SA & India developed financial service sector that can play role in the group • Currently level of multilateral trade limited • Degree of bilateral integration measured using trade- combined index for SA & China shows trade balance in favour of China

Measuring Degree of Bilateral Trade Integration Using Trade Combined Index (TCI) • TCI adapted from Gang Jianhua et al. 2016 • TCI measures the degree of bilateral trade integration, for South Africa & China defined as I SAC = (X SAC / X SA )/(M C /M W )………………………………..………(1) Where: X SAC =Exports from South Africa to China X SA =South Africa’s total export M C =Total import of China M W =Total import of the whole world • If ( X SAC ) is greater than 1, that is, the two trading countries are more intensively integrated (or combined) than the world average. • Greater TCI means the more intensive the trading relationship

Degree of integration, TCI for Trade between South Africa and China Figure 2 (a): The trade combined index of I SAC and I CSA Figure 2 (b): The trade combined index of I SAI and I ISA (US$) (US$) 0.0035 3.50 0.003 Trade 3.00 Combined 0.0025 Trade Index ISAC 2.50 Combined 0.002 Index ISAI % 2.00 % Trade Combined 1.50 0.0015 Index ICSA Trade 1.00 Combined 0.001 Index IISA 0.50 0.0005 0.00 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Year Year • I SAI from 2006 until 2015 was greater • Both I SAC and I CSA are less than 1, with the I SAC much greater than I CSA from than 1 percent through the period 2009 until 2015 while I ISA was less than 1 percent since 2006 until 2015 • The result shows that South Africa’s dependence on China’s market is greater than China’s dependence on South Africa’s market .

Single Currency Theoretical Arguments • Single currency based on price and wage symmetry within group (Mundell, 1961) • High degree of economic openness between nations in an optimal currency area (Mckinnon, 1963) • Mkenda (2001) used General Purchasing Power Parity (PPP) method in East Africa to test:  Cointegration between Real Exchange Rate (RER)  Long-run relationship between RER • Countries that trade together are more likely to have business cycles that are highly correlated (Frankel & Rose, 1997) • Several studies on trade impacts of currency unions produced mixed results [Souza (2002); Bun et al., (2002); Nardis & Vicarelli (2003); Baldwin et al., (2005); Flam and Nordström (2003) & Faruqee (2004)]

Intra-BRICS trade • China was the leading trade partner for BRICS countries • South Africa's share was the smallest in each of BRICS markets

Economic performance trends in BRICS countries Figure 2: Exchange rate in BRICS countries Figure 3: GDP growth rates in BRICS countries • Currencies have been weakening . against the US dollar during the period

Data analysis and procedures • Used time series data analysis in a multi-variate context from 2002-2012 • Data was collected from various sources • The study made use of VAR • Augmented Dickey-Fuller, Phillips-Perron test and Kwiatkowski, Phillips, Schmidt and Shin • Previous studies employed cross sectional & panel data framework (Quinn 1997, Kraay 1998, Rodrik 1998; Klein and Olivei 1999, Edwards 2001, Reisen and Soto, 2001, Edison et al, 2002, Klein 2003)

Vector Auto-Regression Analysis • Cointegration tests were done using PPP US$ conversions • PPP is an economic theory that compares different countries' currencies through a common "basket of goods" approach.

Cointegration Results • Trace test results shows at least 3 cointegration equations in VAR model • Eigenvalues provides cointegration in BRICS currencies in a long run

Cointegration Results • SA currency has been losing PPP compared to other BRCS countries

Correlation, Normality & Residual Stationarity Tests • P-value at lag 2 is 39% • larger than the critical p-value at 5% level • Figure 5 shows that residuals are mean • we fail to reject the null reverting

Proof for the Vector Auto-regression (VAR) Model • Below figure shows the proof that VAR model is stable • All dots fall within a circle

Concluding Remarks • To be a member of a BRICS single currency many constraining factors will have to be aligned for optimal benefits. • Initially maybe difficult to ensure successful operations with a BRICS single market for goods, services, capital & labour. • Accession to a single currency is a process of financial integration that should be a long-term goal. • Adopting the BRICS single currency demands extensive preparations  Economic and legal convergence.  Design economic criteria  Use the exchange rates instead of PPP in order to compare the results  Check the volatility of each of the BRICS countries’ currencies  Check systemic risks inherent in the currencies. • Rather consider other common payment mechanisms in the short to medium term

Thank you Contact details: jjosie@hsrc.ac.za Ronney.Ncwadi@nmmu.ac.za bsiswana@hsrc.ac.za