wang xin (beijing sept 2010)

The Rise of BRICs’ International Financial

Power

and Its Implications* (first draft)

Xin WANGSchool of Finance

University of International Business and [email protected]

AbstractIn recent years, with increased financial openness and significantly raised external investments of various kinds, plus the fact that China and Russia have become net capital exporters and their currencies in their respective regions have become more influential, the international financial power of BRIC countries has been strengthened. However, the rise of BRICs’ international financial power is not proportionate to their development in real economy and external trade, and their foreign investments are mainly in the form of foreign exchange reserve investments. This is a direct result of BRICs’ lagged domestic financial development.

The moderately enhanced power of BRICs is advantageous to providing low-cost capital to international market, safeguarding international financial stability and promoting international financial system reform. But the four countries are still in unfavorable positions in the international division of labor, which determines that they can hardly exert major influence on the international financial governance and the adjustment of global imbalances.

In the future, the strengthening of BRICs' international financial powers and their economies' sustained and stable development depend to a large extent on their domestic financial development. Therefore, BRICs should accelerate their domestic financial reform and endeavor to develop financial markets, further reinforce trade and investment relations among the four countries and between BRICs and other economies, as well as strengthen BRICs’ policy coordination with respect to important international financial issues.

* The views expressed here are those of the author and should not be attributed to any organization. The author would like to thank Fan QI and Ying CUI for their excellent research assistance and for translating the Chinese version into English.

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Along with a rapid growth of real economy and foreign trade, BRIC countries' international financial power and influence have been gradually increasing. Whether or not these four countries can exert very important impact on the international financial stage in the future, especially their potential role in the international financial governance, etc., have become issues of general interest around the world. This paper documents BRICs’ rise in international financial power and its limits, analyzes the relationship between their international financial power and domestic financial development, studies BRICs’ impact on international financial system and governance, and presents concluding remarks.

I. The moderate rise in BRICs’ international financial powerIn recent years, the BRIC countries have been actively participating in the economic and financial globalization, achieving relatively quick overall economic and external trade development and increased international financial power and influence. However, due to lagged domestic financial development, BRICs’ international financial power as a whole is relatively weak considering their positions in the world economy and foreign trade.

1. The international financial power of BRICs gradually risesBRICs' ratios of external financial assets and liabilities to GDP have been rising, representing their higher financial openness. External financial assets and liabilities reflected in the International Investment Positions (IIP) are the synthesized results of an economy's international payments in years, which serve as better guides to this economy’s capital restrictions and cross-border capital flows than the De Jure policies and regulations. The possible problem of excessive fluctuation of international payments in flow data can be avoided by using stock data. According to Table 1, in recent years the ratios of external assets and liabilities to GDP of BRIC countries demonstrate a trendy increase. After the outbreak of the 2007 sub-prime mortgage crisis in the United States, due to dramatic changes of exchange rates and cross-border capital flows, the external assets and liabilities of BRICs have undergone substantial variation.

Table 1 The BRICs’ ratios of external assets and liabilities to GDP (%)External assets/GDP External liabilities/GDP net external assets/GDP

Russia Brazil China India Russia Brazil China India Russia Brazil China India

2004 69 22 48 25 70 67 34 33 -2 -45 14 -8

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2005 68 19 55 23 72 57 36 31 -4 -38 18 -8

2006 74 22 64 28 78 57 40 35 -4 -35 24 -7

2007 84 27 71 35 96 69 36 40 -12 -42 35 -5

2008 61 25 65 29 46 42 32 34 15 -17 33 -5

Source: IMF, International Financial Statistics.

The indicator of financial integration (FI, the sum of external assets and liabilities relative to GDP) can better reflect a country's financial integration with the outside world. However, external assets include reserve assets, and the rise of external assets and hence the financial integration level resulted from the accumulation of foreign exchange reserves does not necessarily reflect a relaxation of capital restrictions or a strengthening of private external investing capabilities. Probably to the contrary, this fact to a large extent illustrates that many capital restrictions still exist in these economies, and that private capital outflow channels are limited. Deducting reserve assets, the adjusted financial integration indicator (FIA=FI*(1-reserve assets/external assets)) will more accurately reflect degrees of a country's financial openness and capital account liberalization (Wang 2010).

Table 2 shows that in recent years, even with frequent fluctuation, BRICs’ FI generally rose. In 2008, right after the financial crisis, the four countries' FI all declined as a result of contracted international financial activities. Among the four, Russia's FI is the highest, with China and Brazil in the middle, and India the lowest. The picture is different when the impact of foreign exchange reserve is considered and FIA is used for a judgment: since 2004, Russia and Brazil's FIA decreased and India's increased, while China's FIA firstly went up and then down. In 2009, Russia's FIA is the highest, with Brazil, China and India ranking successively (Figure 1). Russia's FIA is higher than that of South Korea, but it is significantly lower than Japan and Germany. In comparison, China's current FIA is lower than that of West Germany in 1980, and is comparable to that of Japan in the mid-1980s.

Table 2 BRICs’ financial integration before and after adjustment

India Brazil China Russia Japan

South

Korea Germany

FI FIA FI FIA FI FIA FI FIA FI FIA FI FIA FI FIA

2004 0.58 0.08 0.90 0.58 0.82 0.27 1.39 0.97 1.37 1.09 1.03 0.41 3.05 2.99

2005 0.55 0.10 0.76 0.51 0.91 0.30 1.39 0.90 1.66 1.33 1.07 0.46 3.44 3.36

2006 0.64 0.12 0.79 0.51 1.03 0.37 1.52 0.89 1.78 1.44 1.17 0.57 3.66 3.59

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2007 0.75 0.15 0.96 0.49 1.08 0.39 1.80 1.01 1.88 1.54 1.36 0.76 3.84 3.77

2008 0.63 0.17 0.68 0.36 0.98 0.33 1.06 0.62 1.61 1.32 1.19 0.70 3.72 3.65

2009 0.74 0.20 0.99 0.49 1.04 0.30 1.71 1.03 1.78 1.47 1.63 0.90

Note: FI= (external financial assets+ external financial liabilities)/GDP FIA= FI* (1-reserve assets/external assets).Source: IMF, International Financial Statistics.

BRICs’ External assets have been increasing, particularly reserve assets. In recent years, with various external investments on the rise, BRICs become a power in the international financial market that cannot be neglected. Seeing from the perspective of outward foreign direct investments, according to statistics of the United Nation Conference for Trade and Development (UNCTAD 2010), the four countries' outward FDI started to grow rapidly from a relatively low level since 2005, and reached $147 billion in 2008, accounting for 9% of the world’s total for that year-the same ratio was less than 1% a decade ago. Considering outward FDI stock value, Russia has the largest stock, China and Brazil are in the middle, and India is the last one. China's outward FDI may soon overtake Russia's, as China has a much larger economic scale and a faster economic growth rate that provide higher FDI growth potential. Currently, compared with FDI inflows, BRICs' outward FDI are still small. By the end of 2009, the respective FDI stock values of BRICs are: $157.7 billion for Brazil, $229.6 billion for China, $77.2 billion for India, $248.9 billion for Russia (estimated), totaling $713.4 billion. By contrast, the total direct investment liabilities of BRICs are $1290.4 billion.

The external portfolio investments (reserve investments excluded) and BRICs’ bank loans to non-residents have shown a quick increase from a relatively low starting point, but the values are still small compared with BRICs’ economic scale, which may derive from the fact that the four countries have maintained certain restrictions on these two volatile capital flows. Take China for instance, resident individuals and enterprises can invest orderly in foreign financial markets through the Qualified Domestic Institutional Investor (QDII) scheme, however, licenses and investment quotas for QDIIs must be granted by government agencies. In recent years, financial institutions of the four countries have gradually enlarged their external lending, but their businesses are next to nothing compared with those of the world. According to BIS statistics, by the end of June 2009, China and India both have $104 billion external bank

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lending outstanding, and the data for Russia and Brazil are $147 billion and $96 billion, respectively. The sum of the four countries outstanding external bank loans only accounts for 2.1% of the aggregate of the world. Although China's commercial banks have extended huge domestic loans, their external loans are very small, with policy banks mainly in charge of this business.

Among the many kinds of external assets of BRIC countries, the fast growth of foreign exchange reserve is the most noticeable thing. China and India's reserve assets occupy over 70% of their respective external assets, which are especially high, and Russia and Brazil's shares are also much higher than developed economies (Figure 3). Across the world, BRICs’ reserves account for more and more of the global reserves, and China has the highest number.

Table 3 BRICs’ foreign exchange reserve shares in the world (%)

　 2005 2006 2007 2008 2009

Russia 4.22 5.78 7.15 5.81 5.38

Brazil 1.25 1.63 2.69 2.64 2.92

India 3.51 3.79 4.62 3.43 3.42

China 19.11 20.58 23.10 26.80 30.02

Total 28.09 31.79 37.56 38.68 41.74


For an emerging economy, the rise of its foreign exchange reserve is good for enhancing external payment abilities and preventing from cross-border capital flow shocks. Nevertheless, whether or not reserve increase will necessarily cause international financial power to sharply rise is debatable. During the periods of Gold Standard, Gold Exchange Standard and Bretton Woods System, most of the countries' currencies were linked to gold one way or another, and gold was the last resort of payment. Through current account surplus, a country could gain gold, which was vital to the stability of its gold standard and financial system. After World War II, the United States owned 3/4 of the global monetary gold reserves, enabling it to seize the hegemonic status financially in the world at that time. However, gold standard has already been replaced by credit currency system, and a country’s foreign exchange (FX) reserve is

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denominated in certain major international currencies, which must be invested in related countries’ financial markets. In situations where reserve currencies depreciate against the country’s domestic currency, or the financial asset yields of the reserve currencies’ issuing countries decrease, or prices of goods and services denominated in reserve currencies rise, etc., this country may suffer from big losses. After reaching a certain level, which might not be easy to define, the costs of FX reserve for a country will become more evident. Therefore, FX reserve accumulation is a double-edged sword and cannot necessarily translate into a proportionate rise in its international financial power.

China and Russia have gained net creditor status. Since 2004, Chin’s net foreign assets have become larger and larger compared with domestic GDP, while Russia also became a net creditor in 2008. Due to impacts of international financial crisis, Russia and Brazil’s net assets (liabilities) have changed dramatically. Relative to other emerging economies relying heavily on foreign capital inflows, China and Russia, as net creditors, can better avoid risks associated with international payments. But whether or not this indicates these two countries have become international financial powers is worthy of further analysis. From the developed countries’ history, we can see that along with the rise of real economic powers, the United Kingdom in the second half of the 19th century and the United States after the beginning of the 20th century both had net external capital outflows and then became financial powers in the world. Japan and West Germany behaved the same way in the 1960s and 1970s. However, over-exaggerating implications of net external assets on emerging economies is fallacious. Take China as an example, China is exporting net capital at a time when its income and capital stock per capita are still quite low, which means that China’s precious financial resources are taken advantage of by other countries instead of being used in domestic consumption or investments, reflecting to a large extent an undeveloped domestic financial market and weak abilities to efficiently allocate resources (Wang 2007). In the long term, this is not favorable to China's economic development and enhancement of her international financial power.

Some financial institutions in BRICs have increased their international exposure, and domestic currencies of China and Russia start to “go global”. More and more financial institutions of BRIC countries, in pace with the rise of their strength, begin to enlarge their foreign businesses. But they are still at the

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early stage. On the whole, there are only a few financial institutions that possess relatively high international competitiveness and run businesses globally. In China, though many financial institutions are among the global leaders in terms of market capitalization and they excel in fast business expansion and a high profitability-even better than many peers in other countries, their income sources are still concentrated on domestic market. According to the statistics of China Banking Regulatory Commission,1 as of the end of 2009, five large Chinese commercial banks had invested in five foreign institutions, by acquiring or investing in shares and with a total acquisition value of $7.13 billion. By the end of 2009, Chinese banks’ external assets accounted for only 2.3% of their total assets. According to the statistics of Brazilian Central Bank, the share of Brazilian banks’ external assets was merely 2.5%.

As a result of China’s significant rise in national economic and external trade strength, the foreign demand for renminbi has increased. China is now conducting the pilot program of cross-border trade settlement in renminbi, which experiences relatively high growth in business since 2010. By the end of July 2010, banks

have accumulatively handled ￥ 91.64 billion cross-border trade

settlement business in renminbi, which only accounts for a very small share of China’s total foreign trade value. Currently, China is providing settlement arrangement for RMB businesses conducted by banks in Hong Kong and Macao, including RMB deposits, loans, remittances, currency exchanges and bond issuance etc. However, by the end of August 2010, RMB deposits in Hong Kong is only about

￥ 100 billion, accounting for approximately 1.8% of the total

banking deposits in the territory. In the coming years, given China’s booming economy and foreign trade, and market expectation of RMB appreciation, RMB’s “go global” business has much room for development, but the process should be a gradual one. RMB is not yet fully convertible and still has a long way to go before becoming an international currency. In Russia, after announcing the convertibility of Ruble in the second half of 2006, the authorities actively pushed Ruble’s internationalization, especially commodities trading in Ruble. Unfortunately, after the deepening of the global financial crisis, amid large capital outflows and domestic market turbulence, Ruble experienced sharp depreciation and its internationalization process encountered headwind. India and Brazil are even further away with respect to domestic currency

1 China Banking Regulatory Commission, Annual Report 2009.

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internationalization.

2. BRICs’ rise in international financial power is not proportionate to their economic and trade developmentIn recent years, BRIC as a whole has achieved relatively high economic and foreign trade growth, resulting in further enhancement in their status in the world economy. According to statistics from IMF World Economic Outlook, based on PPP, the four countries’ GDP accounted for 13% and 16% for 2007 and 2008 respectively, and this ratio reached 23.5% in 2009, which was 7.2 percentage points higher than that of 2000. China alone takes over a half of four countries’ GDP. After the international financial crisis, BRICs’ contribution to world economic growth is more evident. In the first half of 2010, China, India, Brazil and Russia accomplished growth rates of 11.1%, 10.6%, 8.9% and 4.2% respectively, with most of the developed countries in sluggish.

The development of BRICs is reflected particularly in foreign trade. From 2006 to 2008, the average annual growth rates of foreign trade for BRICs are 24.3%, 21.2% and 31.3%, respectively, and are 15.5, 14.1 and 28.6 percentage points higher than those of the world. But BRICs’ foreign trade decline after the latest global financial crisis was also extraordinary. In 2009, the foreign trade value of BRICs fell 21.2% year on year, 10.5 percentage points more than the decline of the world trade value.

Compared with their economic and foreign trade development, BRICs’ international financial power has moderately increased. From 2004 to 2008, the ratio of BRICs’ GDP to that of the United States, EU and Japan combined had been on the upswing, increasing by 11 percentage points; the ratio of total imports and exports of BRICs to that of the three developed countries or regions rose by a faster pace of 16.2 percentage points; the ratios for outward foreign direct investments, outward portfolio investments and other investments had gone through much variation, with no ratio rising more than 2.4 percentage points in five years.

Table 4 BRICs’ economic and financial strength relative to those of

developed countries (%) *

Year GDP Imports and

Exports

Outward Foreign

Direct

Investment

Foreign Portfolio

Investment

Foreign Other

Investment

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2004 13.0 27.9 4.0 1.1 4.6

2005 15.1 32.2 4.8 1.3 4.9

2006 17.3 35.9 5.9 2.1 4.6

2007 20.2 39.4 7.1 2.0 5.3

2008 23.9 44.1 6.4 2.5 6.9

*Ratios of BRICs economic indicators to those of the United States, EU and

Japan combined.


BRICs’ expansion in external investments falls behind the development of real economy and foreign trade, to a large extent due to the four countries’ lagged domestic financial development in general, and underdeveloped financial markets in particular. According to Bank for International Settlements statistics, by the end of June 2009, the domestic debt securities outstanding of China, Brazil, India and Russia was $2307 billion, $1088 billion, $520 billion and $36 billion respectively, a mere 6.4% of the world’s total. As of the end of 2009, the stock market capitalization of China, Brazil, India and Russia was $3314 billion, $1339 billion, $1260 billion and $476 billion respectively, totaling 14% of the global stock market capitalization. Concerning the ratio of the sum of equity and debt market capitalization plus bank credits to GDP, China ranked the first in BRICs at the end of 2008 with this ratio close to 2, yet the same ratios for the United Kingdom, Germany and Japan all exceed 3.5 (Figure 4). Due to the underdeveloped domestic financial markets and limited capabilities of financial regulation, BRICs cannot afford to fully liberalize their capital accounts or open their domestic financial markets. As a result, they are not able to promote private outward investments or attract foreign capital on a large scale, hindering the enhancement of the four countries’ international financial power.

The gap between emerging economies such as BRICs and developed economies in financial development may continue to exist or even get wider. In the past two decades, against the backdrop of an increasing degree of economic and financial globalization, certain division of labor has taken shape between developed economies and emerging economies in terms of real economy (foreign trade) expansion and financial development. Although the emerging economies progress fast in foreign trade, developed countries’ domination in international finance is strengthened. In regard of the ratio of external financial assets and liabilities to gross imports and exports, industrial economies’ ratio has been on a relatively quick

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rise since the mid-1970s, while the ratio for emerging economies and developing countries as a whole, though increased during the period between the mid-1970s and the mid-1980s, has changed little or even declined since then (Figure 5). In the past decade, the above ratios of BRICs have not maintained continuous growth, and in some years they decreased (Figure 6), indicating their lagged international financial development relative to that of the foreign trade.

After this round of financial crisis, developed countries’ financial systems are heavily damaged. The situation that their financial sectors over-expanded relative to real economies may change, and the developed countries’ financial advantages get impaired. However, the gap in financial development between developed and emerging economies is still wide, and the resilience and adjustment capabilities of developed economies cannot be neglected. In light of concrete measures by developed economies to fix their financial systems and strength financial regulation, in the short term, it is not realistic for BRICs to rapidly fill this gap.

II. The implications of BRICs' rising international financial powers on international finance and its governance

The rise of BRICs’ international financial strength will have some positive impact on the international financial system and its governance. An objective and practical evaluation should be done about this.

The large amount of capital outflows from BRICs facilitates the development of global economies. In recent years, BRICs have been increasing capital outflows mainly by means of foreign exchange reserve investments, which make up the current account deficits of developed countries such as USA and UK, and conduce to reducing the long-term interest rate of international market and stimulating global economic growth. According to a report by the research arm of the US Congress on China's holding of US Treasuries bonds, which was published in July 2009, had China hadn’t make a large-scale purchase of its government bonds, the U.S. interest rate would increase by 0.5 percentage point. Recently, the U.S. economy has undergone a feeble recovery, with a continuously high unemployment rate and the possibility of "double dip" that cannot be ruled out. The growth of Euro zone and Japan's economies is also slow. At this time, the relatively rapid economic growth of BRICs and their enlarged external investments will definitely exert greater

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influence on the stabilization and recovery of global economies.

The capital outflows of BRICs are very helpful for the alleviation of the credit crunch of developed economies, safeguarding the stabilization of the international financical markets. Since the outbreak of the U.S. Sub-prime mortgage crisis, the international financial markets have suffered dramatic turbulence, and financial institutions in many developed countries have gotten big hits. In order to stimulate their economies, developed countries have adopted very loose fiscal and monetary policies one after another, causing their government debts relative to GDP to surge dramatically. In September 2009, when financial crisis deteriorated acutely, BRIC countries increased their purchase of U.S. treasury bonds instead of reducing their holdings, which had a vital and positive impact on the United States' efforts to fight against the crisis actively and to avoid the crisis contagion. According to the statistics released by the US Treasury Department, in October 2008, the holdings of U.S. treasury bonds of BRICs increased by 18.4% comparing with those in June the same year. As of the end of June 2010, the total investments outstanding of BRICs to U.S. treasury bonds was $1,160 billion (China’s holding was $840 billion), which accounted for 29% of U.S. treasury bonds held by foreign investors. In the near future, the financing demand of government and financial institutions of developed countries would be huge. It was estimated by IMF (2010) that in the next three years the due debt of banking institutions will amount to $5 trillion, posing great pressure on re-financing.

Some observers consider that China is likely to undersell U.S. treasury bonds in large number, causing dramatic turbulence in global financial market. Professor Prasad (2010) of the Cornell University regards that China's loss from doing that is not as big as some people think it is, hence the threats of China's underselling U.S. treasury bonds are well convincing. However, since the width and depth of the U.S. bond market are unrivaled, as long as China continues to accumulate foreign exchange reserve in a fast pace, it will not make a wholesale diversification away from U.S. treasury bonds. In my own opinion, along with a fast increase in a country's foreign exchange reserve, it is quite natural to adjust appropriately the currency structure and asset structure to avoid risks. However, the higher the ratio of foreign exchange reserve to external financial assets a country has, the larger the share of this country's reserve in global foreign exchange reserves, and the closer the economic ties among this country and its investments subject countries, the

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smaller possibility that this country will adjust its foreign exchange reserve's asset structure sharply in a sudden. The reason is simply that the stake is just too high and the outcomes might be too severe. Besides, the larger the foreign exchange reserve gets, the more difficult to adjust its investments technically.

In normal cases, official foreign investments are more rational than private investments, and will increase, not reduce, the stability of the international financial market. Foreign exchange reserves and sovereign wealth funds usually concentrate on long-term investments and will not change their investment strategies on the basis of short-term market fluctuations. This investment pattern is sharply different from that of private investors who are keenly after short-term profits. Research shows that during the periods of U.S. Dollar depreciation, foreign exchange reserve usually increase their holdings of dollar assets (Wong 2007), playing a stabilizing instead of destabilizing role. Furthermore, official investment institutions unavoidably tend to relate such issues to international relations and geopolitics, therefore, their investments are helpful to the stability of international financial market. Deep worries raised by some western countries’ commentators concerning big negative impacts of China and Russia’s investments are unfounded and even counterproductive.

The rise of BRICs’ international financial powers promotes the international monetary system reform. The large amount of foreign exchange reserve accumulation and investments leads to a closer relationship between BRIC countries and international monetary system. This to some extent increases the negotiating status of these countries. In April 2009, Governor Zhou Xiaochuan of the People’s Bank of China, which is China’s central bank, brought forward the suggestions on reforming the current international monetary system and letting the Special Drawing Right (SDR) play a more important role in international financial transactions (Zhou 2009), which immediately attracted major attention of the international community. Nevertheless, in addition to the factors mentioned above, there are some reasons determining that it is less likely that dollar assets will be undersold on large scale or that the international monetary system dominated by U.S. dollar will undergone fundamental change. On the one hand, financial markets of other countries can not rival the U.S. in their depth and width, therefore can hardly absorb huge reserve investments. On the other hand, if a large amount of investments diversify away from U.S.D assets into assets denominated in other currencies, those related

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economies will have to face problems of fast capital inflows and sharp currency appreciation, adversely impacting their export expansion and economic growth. Recently, some Japanese government officials have voiced a concern that China's large amount of Japanese bond investments may cause the yen to appreciate. In mid-September, 2010, Japanese government intervened in the FX market to arrest the JPY appreciaton, a move that has not been taken since early 2004. The effectiveness of the intervention and its implications for the Japanese attitude to China’s investments remain to be seen. Nevertheless, it is fair to say that even though foreign investors are not so happy about the safety and profitability of USD assets, they don’t have much room for manuvaour and therefore, the current international monetary system dominated by the USD will not experience a quick adjustment.

Along with significant increase in their economic and financial powers, BRIC countries' currencies have the potential to become internationalized, enhancing the multi-polarization of the international monetary system. However, since their domestic financial markets are still underdeveloped and their economic growth is still more or less dependent on net export, BRIC countries still cannot afford to let their currencies move freely against the USD for the sake of economic and financial stability. On top of that, the convertibility and the internationalization of BRICs’ currencies can hardly advance as fast and smoothly as some expect. BRICs and some other emerging economies will continue to accumulate FX reserves and invest in the U.S. financial markets, strengthening the international monetary system dominated by the United States.

The voices of BRIC countries in international financial stage have increased, but hardly very influential. BRIC countries’ shares in international financial organizations have long been small, and their voting rights and voices only got promoted in recent years. After the latest capital injection of the World Bank on April 25th 2010, China's total voting rights rose from 2.77% to 4.42%, ranking the third in the world. China's voting rights in the International Finance Corporation of the World Bank Group rose from 1.02% to 2.29%, which is still a position behind the U.S., Japan, UK, France and Germany. At present, China's quota in the IMF is only 3.72%, ranking the 6th in the world. In 2009 Pittsburgh Summit, G20 leaders promised that before the beginning of 2011, developed countries would transfer at least 5 percent of IMF quotas to rapidly growing developing countries and emerging economies in order to reflect the

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tremendous changes in the global economy. As the biggest country whose quota is undervalued, China is most likely to gain new quotas.

Table 5 BRICs’ shares of quotas and voting rights in the IMF and the World Bank (%)

IMF quota

IMF voting rights

World Bank voting rights

GDP shares in 2009

（PPP）

China 3.72 3.65 4.42 12.52Russia 2.73 2.69 2.77 3.05India 1.91 1.88 2.91 5.06Brazil 1.4 1.38 2.24 2.87

Sources: IMF and World Bank websites.

After the international financial crisis, the Financial Stability Board exerts very important impact on discussions about economic and financial policies and key issues such as financial regulatory reforms. Among emerging economies, only BRICs have three seats respectively-the same as the G7 countries. China and Brazil also send rotating members to this term of Board of Directors at the Bank for International Settlement, an international financial organizaton that is playing a leading role in the debate of monetary and financial policy issues.

However, the increased quotas and voting rights of BRICs are more symbolic than realistic. Despite a willingness of China and other countries whose quotas are undervalued to enhance their quotas and voices in international organizations, the European countries whose quotas are widely believed to be overvalued will not let this happen and the United States will strive to maintain its quota in the IMF exceeding 15% in order to have vetoing rights on important issues. In addition to BRICs’ insufficient quotas, the fact that only a small number of middle and higher-ranking management staff comes from BRICs (India might be an exception) will substantially weaken their clout in agenda setting, policy debate and ultimately the policymaking in international financial institutions. Although BRICs have become more visible on the international stage and voiced their concerns more regularly about the reform of international financial institutions, monetary system and financial regulations, they still cannot get into the core decision-making circle. Lack of large amount of talents and in-depth research on

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various important issues also contributes to this fact. The differences among BRICs themselves in terms of international relations, economic and financial development priorities will make it difficult for them to speak in one voice.

In conclusion, the impact of BRICs and other emerging economies on international financial governance heavily depends on their own economic and financial powers. Although China, Russia and other countries have had a relatively rapid foreign exchange reserve increase, they cannot get rid of their reliance on developed financial markets after all. Only when their domestic financial markets reach a certain level of development and internationalization and become important platforms for international investments and financing, can they truly participate in the formulation of international financial rules and exert material impacts on international financial governing. UK at the end of the 19th century and USA after the beginning of the 20th century respectively became dominating financial powers in the world due to their most developed financial markets at those times.

It is not realistic to count on emerging economies to exert major influence on the adjustment of global imbalances. The issue of global imbalances is not a new one, and has long been controversial. 2In the early 1940s, when the U.K. and the USA negotiated the blueprint of the future international monetary system, Keynes strongly proposed that in order to achieve international payment balance, both surplus countries and deficit countries should conduct necessary adjustments instead of keeping requiring deficit countries to curb domestic demand. The United States, however, relying on its powerful economic and financial strength, insisted that the adjustment must mainly be made by current account deficit countries. When necessary, according to the US’s plan, international organizations could even intervene in deficit countries sovereign issues to safeguard the painful domestic demand reduction had they are reluctant to do so (Dormael 1978). Ironically, today the biggest deficit country is pressing very hard the surplus countries to assume major responsibilities in the adjustment of global imbalances by currency appreciation and so on. As a matter of fact, the current global imbalances result from structural causes from many facets, including a relocation of middle and lower-end manufacturing industries from developed economies to China

2 During the most parts of the first 70 years in the 20 th century, the United States maintained current account surplus, while the United Kingdom experienced continued deficits. After 1970s, Japan and West Germany (and Germany after unification) began their sustained surpluses, and the current account deficits of the United States have become larger and larger.

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and other emerging economies in the context of globalization, which causes these economies to produce and export more, increasing their trade surpluses. Given an increasing scale of cross-border capital flows and extremely volatile international financial markets, emerging economies, with underdeveloped domestic financial markets and relatively weak capacities to withstand financial risks, have to build up foreign exchange reserve to guard against potential external shocks, which also is an important reason for global imbalances.

The balance of payments conditions of the four BRIC countries are not the same, which determines their different roles in global imbalance adjustment. Both China and Russia have current account surpluses, yet India and Brazil retain deficits (Figure 7). 3However, the foreign exchange reserves in China, Russia and India are all increasing fast, which are then used to invest in financial markets of developed countries like the U.S., helping greatly the U.S.’s efforts to finance its current account deficits.

The above analysis shows that the rise of international financial power of BRIC countries characterized by increasing foreign exchange reserves has not led to significant impact on the current international monetary system and international financial governance. In the course of unceasing economic and financial opening up of the four countries, they all have relatively strong motives to continuously accumulate foreign exchange reserve to avoid risks. Building a more efficient international financial safety net and strengthening regional monetary and financial cooperation will to some extent reduce the emerging economies’ incentive to accumulate reserves. But the related reforms could not be easy. Besides, when stuck in plight, it may not be that easy for emerging economies to secure enough financing support conveniently from reformed international financial organizations (Jeanne 2010). Therefore, many emerging economies will continue to save a lot, leading to their account surpluses.

Moreover, with underdeveloped financial markets and a lack of consumer financial products and services, many emerging

3 India’s current account deficit accounts for about 2 percent of its GDP, which is mainly offset by private capital, particularly portfolio investment inflows. Brazil will need to invest in huge amount for the next World Cup and other important events in the next few years. Until 2016, it is estimated that the ratio of Brazil’s current account deficit to GDP will rise from the recent 1-2% to 4-5% (Goldfajn 2010).

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economies are not able to easily transform from an export-dependent growth model to a consumption-driven one. Therefore, they do not like to see their currencies appreciate too quickly, resulting in their rising foreign exchange reserve. Seen from the perspective of the United States after the financial crisis, because of a moderate economic rebound and high unemployment pressure, the United States is likely to continue its stimulus package financed by government bond issuing and foreign capital inflows. It still has the privilege to make good use of the USD-dominated international monetary system, which means that the global imbalances will not be eased in the near future. In fact, this problem has recently shown traces of worsening again. It is obvious that the issue of global imbalance is related to the international environment as a whole, and that counting on emerging economies like China to exert major influence in the adjustment of global imbalances is simply unrealistic.

Overall, in the short term, the rise of international financial power of BRICs mainly characterized by increasing foreign exchange reserves is advantageous to providing low-cost capital to international market and promoting the international economic development and financial stability. Although these four countries have somewhat strengthened their status and raised their voices in the international financial stage, their influence is still rather limited. If there are no essential changes taking place in the economic and financial policies of both developed countries and emerging economies, the global imbalances, instead of being alleviated, might get worse and lead to devastating outcomes in the future.

III. Concluding remarksIn recent years, accompanying the rapid economic growth, BRICs’ financial opening–up levels and international financial power have been rising, which is mainly reflected in the following aspects: significant increase in various external investments, emergence of more cross-border corporations and financial institutions that have international influence, rising external financial assets and liabilities, net export of capital by China and Russia, and increasing impact of domestic currencies in their respective regions. Comparatively, China’s international financial power is stronger, but the four countries’ international financial strength, which is mainly reflected in their rising official foreign exchange reserves, is not proportionate to the scale of their real economy and their contribution to the global economy. This is possibly because of their lagged domestic financial development, which has led to a slow progress in BRICs’

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currency convertibility and financial opening process especially in India and China . In the international division of labor against the background of economic globalization, BRICs are placed in inferior positions.

BRICs’ moderately strengthening international financial power and increasing external investments are helpful to providing low-cost capital to international market and to safeguarding international financial stability, and have to some extent increased their voices in international finance. However, BRICs are still highly dependent on international financial markets. As a result, they cannot have material impact on international financial governance, nor will they be able to exert major influence on the adjustment of global imbalances. It is worth noticing that overstating BRICs’ international financial powers and their impact and implementing protectionist practices on the excuse of these overstatements will hurt the healthy development of international finance.

Looking ahead, whether or not BRICs can exert more influence on the international financial stage mostly depends on their healthy economic and financial development. Historically, with a higher bar in terms of institutional requirements, financial development in many countries can often be seen to fall behind their economic growth. For instance, during the period from the end of the 19th

century to the early 20th century, without a central bank, the United States had already become the largest economy in the world. At that time, the financial markets of the U.S. were frequently in turmoil, with relatively small stock trading volume, widespread speculation and market manipulation, and high fluctuation in market prices. From 1870s to the World War I, six major financial crises had broken out in the United States. Japan has long been the second largest economy in the world, but there is still a great gap in the level of financial development compared with the United States and the United Kingdom. Although the Japanese government has endeavored to promote the internationalization of the Japanese yen and the scale of economy and external trade of the UK is well behind Japan, the internationalization level of JPY is still lower than that of the British pound until now. After the collapse of economic bubbles, Japan has sunk into “lost decades”, which is a big blow to the JPY internationalization . It is even harder for developing countries and emerging economies to catch up with or exceed the financial powers of developed countries. The economies of Mexico, Argentina and South Korea have all experienced high growth rate, yet they were all greatly shocked by currency and financial crises.

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Nowadays, China has already become the second largest economy and the largest export country in the world; however, it is the only country among the trading powers whose currency is not generally used in international transactions and it still has a long way to go in terms of financial development and Renminbi internationalization. In all, the current discussions concerning BRICs have been concentrating too much on their economic growth rate and enlarged trade volume, neglecting adverse effects that may be brought by financial disadvantages. The research and judgment with respect to BRICs’ international financial powers have excessively focused on the enlargement of their external investments while ignoring such weaknesses as the high ratio of foreign exchange reserve investments.

In history, whether or not an economy with lagged financial development can realize financial catch-up in time is key to its sustainable and stable economic growth. At the beginning of the 20th century, together with the efforts to further secure its status as the world economic leader, the United States has continuously improved its financial institutions. For example, the year of 1913 witnessed two important advances in US’s financial reform. One is the passing of the Federal Reserve Act; the other is the fierce criticism by jurisprudents led by Mr. Brandeis (Wachtel 2003), which helped preventing financial powers from over-concentrating. After the Great Depression, the United States passed several influential acts successively such as Securities Act and Securities Exchange Act. The improvement of financial institutions has laid a solid foundation for U.S.’s long-term and stable financial development and economic growth.

In complete contrast to the United States, the then flourishing Argentina experienced economic stagnation and upheaval in the most part of the 20th century, which is closely related to its slow financial development. At the late 19th century and the early 20th

century, a great deal of capital and labor flew into this country. Accompanied with the wide and prolific local land, Argentina’s agriculture, manufacturing industry and external trade were booming, indicating a prosperous future.4 However, Argentina’s financial market was very much underdeveloped. It was very dependent on external capital, which can be shown by the fact that before the World War I, half of its domestic industries were

4 In 1913, Argentina’s manufacturing goods production per capita surpassed those of Spain and Italy. Its land was more widely covered by railways than the case in the U.K.（Friden 2006）。In 1870, Argentina’s GDP per capita was 46.3% of that of the United States. The ratio was 49% for both 1890 and 1913. However, in 1950, the ratio fell to 36.2% (Maddison 1995).

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controlled by foreigners. Argentina did not implement the Gold Standard and issued too much money. In order to promote export competitiveness, it frequently used currency devaluation as a tool, therefore impairing market confidence in its currency-even internal financing was often conducted in pound sterling. The first foreign currency-linked domestic bond issuance in modern sense appeared in Argentina in 1872. From then until 1910, another three issuance of domestic bonds and many issuance of foreign bonds by Argentine

entities were denominated in pound sterling （ Reinhart, Rogoff

2009）。

Evidently, without timely improvement of financial institutions leading to financial development, BRIC countries and other emerging economies may be stuck in an unfavorable international division trap for a long time. As a result of underdeveloped financial systems and distorted resource allocation, current emerging “stars” may lose their shine at some point and even experience severe currency and financial crises that may cause long-term economic stagnation. In order to further promote their international financial powers and sustainable and stable economic growth, the BRIC countries should concentrate their efforts on the followings.

First of all, speed up domestic financial reform and endeavor to develop financial markets. The key for emerging economies to exert greater influence on the international financial stage is to promote their own economic and financial power. The literature shows that bringing in more foreign financial institutions and competition, together with a gradual opening of domestic financial markets can be helpful to reducing the power of domestic interest groups and accelerating financial reform and innovation, therefore improving financial service standard and efficiency of resource allocation (Rajan, Zingales 2003). In this process, the BRICs should fully consider the merits of the latest outcomes regarding international financial regulatory reform, strengthening financial regulation and macro-prudential management so as to avoid systemic risk.

Secondly, further strengthen the trade and investment relations among the four countries and between BRICs and other emerging economies. The BRICs’ economies are relatively highly complementary in many aspects. For instance, China and Russia run current account surpluses and export capital as a result, while India and Brazil run current account deficits and need foreign capital

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inflows. Another example is that Russia and Brazil are commodity exporters, while China and India are net importers of many kinds of commodities. By substantially increasing cross-border bank credits and direct investments in the sectors of energy and raw materials among the countries concerned, they can promote mutual benefits and help realize win-win situation. Currently, the industries and financial sector of BRICs and other emerging economies have not built deep understanding and cooperation ties. From the strategic point of views, the governments of these economies should strengthen political trust and economic policy dialogues and coordination, better guide and serve their domestic enterprises and financial institutions, and facilitate international trade and investments. Measures that warrant serious discussion include building cross-nation investment protection mechanism, solving cross-border controversies and investment problems in time, organizing multilateral investment funds to better support investments in infrastructure, new energy, low carbon economy and domestic financial markets of BRICs, and promoting local currency settlements of international trade and investments in order to reduce foreign exchange risks.

Last but not least, strengthen policy coordination and push forward the international monetary and financial system reform. Presently the BRICs have already established regular meeting mechanism of state leaders, ministers of finance and governors of central banks to discuss and coordinate in respect of important issues. Ministers of finance and governors of central banks of BRICs have made a decision to initiate a cooperative research project to study the four countries’ development conditions, experiences, lessons and potential fields for collaboration. These efforts are good for the deepening of understanding among the four, and provide precious experiences to other developing countries and emerging economies. Since the BRICs all greatly benefit from globalization and have close relations with developed economies, they will not become exclusive group, nor will they pose direct and powerful challenge to the current international economic order dominated by developed countries. In the next stage, it is necessary for the BRICs to build closer cooperation mechanisms, welcome more developing countries to participate in dialogues and coordination, increase voices of emerging economies to improve international economic and financial governance, and strengthen monitoring on developed countries’ economic and financial policies, for the sake of a more stable and balanced development of the world economy.

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References

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Dormael, Armand Van, 1978, Bretton Woods: Birth of a Monetary System, The MacMillan Press Ltd.

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Goldfajn, Iian, 2010, “Rebalancing the global economy: A view from the BRICs,” in Rebalancing the Global Economy: A Primer for Policymaking, edited by Stijn Claessens, Simon Evenett and Bernard Hoekman, Centre for Economic Policy

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Figure 1 Adjusted financial integration (FIA) *of BRIC countries

Note: FIA=FI*(1-reserve assets/external assets), where, FI=(external assets+

external liabilities)/GDP


Figure 2 Outward foreign direct investments of BRICs

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Figure 3 The breakdown of external financial assets of BRICs

Notes: a. data as of the end of 2008

b. data as of the end of October 2009


Figure 4 Scales of financial market to GDP ratios of some economies in 2008

(%)

Source: Hansakul et al (2009).

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Figure 5 Relative development of international finance and foreign trade of

different economies*

* represented by the ratio of the sum of external assets and external liabilities

to the total value of foreign trade.

Source: Lane, Milesi-Ferretti (2006).

Figure 6 Relative development of international finance and foreign trade of

BRICs *

*represented by the ratio of the sum of external assets and external liabilities to

the total value of foreign trade

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Figure 7 Current account balance to GDP ratioes of BRICs

Sources: IFS, IMF; Deutsche Bank.

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