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27 June 2012, Gateway House

BRICS: An alternate financial framework

The Western-dominated financial system that is strangling Iran with sanctions today can do the same to BRICS oil exporters tomorrow, should their geopolitics be deemed inconvenient. Hence, there is urgency for the BRICS nations to create a new financial architecture for mutual economic benefit.

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Two recent developments – the $10 billion contribution announced by India to the IMF for the European bailout, and the June 28 deadline on China to submit to US and EU sanctions against Iran – show how exposed the BRICS (Brazil, Russia, India, China and South Africa) economies are to western financial architecture. It is clear that the grouping must now urgently organize itself to build institutions of mutual economic benefit.

The BRICS’ $75 billion contribution to the IMF, announced June 19, is also indicative of how the West has successfully co-opted the emerging economies into submitting to western dominated existing institutions –leaving them little motivation to build their own.

The sanctions against Iran are an acute example of the grip that the West has over the world. BRICS together form a larger oil-importing bloc than the entire European Union.  Although none of the BRICS are in confrontation with Iran, they are nonetheless hostage to the western sanctions imposed on that country because the conduits of international finance, trade and transportation used for crude oil trade are controlled by the West.

The entire pricing framework – including the currency which is U.S. dollar-based – is Western. The New York Mercantile Exchange (NYMEX) and the International Commodities Exchange (ICE), both based in London, conduct the largest trades in the world for crude oil futures contracts. ICE alone conducted $14 billion worth of Brent and $4.8 billion of West Texas Intermediate (WTI) crude futures and options in 2011. This enables them to derive the leading crude oil pricing benchmarks in the world: the WTI and the Brent. This is important because save for the U.S., most countries in the world including India use the Brent benchmark to determine crude oil pricing.

There is also the much-used Society for Worldwide Interbank Financial Telecommunication or SWIFT, the code used globally for most electronic banking transactions, retail or institutional. In March, SWIFT banned Iran’s central bank and commercial banks from conducting business, leaving fuel-dependent importers such as India lurching for payment mechanisms.

Similarly, the sanctions imposed on insurance agencies which insure the ships that carry oil from Iran, have cut off transportation options for BRICS countries. The London-based International Group of P&I Clubs which aggregates 80 reinsurers – like Lloyds – and insures 90% of the world’s ocean-going tonnage for liabilities of up to $60 million, will not issue coverage to ship-owners starting July 1, the date when the EU insurance sanctions against Iran kick in.

In the absence of alternatives, the BRICS have been trying to find creative ways to pay Iran. India worked through banks in Europe, Dubai and Turkey before finally using its own state-owned bank, UCO Bank, to pay for its $10 billion annual oil import bill from Iran. Other small banks, so far hidden from the reach of the sanctions, such as Russia’s First Czech-Russian Bank, China’s Bank of Kunlun and Iran’s Saman Bank, Karafarin Bank and Pasargad Bank, are making up for the constrictions and capitalizing on the opportunity by charging hefty transaction fees of up to 8% on transactions – on top of the 3% banking fees, according to Western reports.

Finding insurance has been harder. The Iran Insurance Company and the Chinese P&I, two companies not part of the London-based IG P&I which so far have been covering shipments to India and China, do not seem to have the financial heft to make up for the shortfall. China’s P&I is not even confident it can support Chinese ships.

As payment options run out, BRICS countries are making individual efforts. India and China considered paying in gold. Bilateral currency swaps of the Iranian Rial with Renminbi, Rupees and Rubles are being used as viable options. India recently lifted the 40% tax on this special foreign rupee payment to Iran.  In return, Iran is planning to use the local BRICS currencies it has accumulated to buy Chinese toys, Indian rice and Russian wheat.

However, none of these options are sustainable. Iran has a trade surplus of $7 billion with China and $8 billion with India. That means trading in local currencies will leave Iran with a large account of mostly unused local currency deposits.

The sanctions are not just an issue for importers. Brazil and Russia are energy exporters, and the Western-dominated system that is strangling Iran, can do the same to them should their geopolitics be deemed inconvenient. Iran today, could be Russia or Brazil tomorrow.

It is therefore urgent that the BRICS quickly work together to create new institutions to counter the domination of the dollar and the West. Apart from the already proposed multilateral BRICS bank, the financial infrastructure should include a clearing union and insurance club to facilitate international trade, finance and transportation. For instance, even though China and India have a deficit with Iran, Brazil and Russia do not. If a new trade settlement system is created – on the lines of the Asian Clearing Union set up in Tehran in 1974 or the International Clearing Union that was proposed at Bretton Woods in 1944 – but with BRICS currencies, it will enable Iran to pay Brazil with the accumulated Rupees or Renminbi, and not be compelled to accumulate rice and toys.

Brazil can use the same system to pay India for its bilateral trade, thereby facilitating multilateral local currency swaps for intra- and inter-BRICS trade. This will side-step the constraints of non-convertible currencies like the Rupee or Renminbi.

Gradually, new commodity exchanges can also be promoted to enable alternate means of price discovery and benchmarking in currencies other than the dollar. India’s Multi-Commodity Exchange (MCX) is already doing crude oil futures contracts. Iranians also launched their own Oil Bourse in Kish in 2008 for trading oil in non-dollar denominated contracts. At the time, BRICS was only an emerging grouping, and gave no collective backing to the effort.

Now is surely the time to activate alternate payment regimes. It will require adjustments by the BRICS and their trading partners. China’s reserves are largely still in dollars; it will have to balance preserving that value with internationalizing the Renminbi – a stated Chinese goal achievable under a new system. External trade partners such as Iran will also have to make a concerted effort to increase trade with the BRICS countries to avail of the new system’s benefits.

Countries like India, a net importer within BRICS, will have to step up economic activity to create exportable products and services of value to its compatriots. In return, China and Russia, both net exporters, may have to patiently hold weaker currencies like the Rupee until a balanced equation is achieved.

Of course there is going to be resistance from the United States and Europe. Not only will they lose control of instruments like sanctions, but an alternative platform will be a direct threat to the almighty dollar-denominated trade and its use as the international reserve currency. The rise of alternative commodity exchanges will be a direct hit to NYMEX and ICE – lucrative businesses which earned record-breaking revenues of over $3 billion and $1.3 billion respectively in 2011.

If the BRICS grouping thinks creatively, it can overcome the risks of facing down the dollar and the West. Much will depend on how China reacts to the June 28 deadline for responding to U.S. sanctions against Iran. It has leverage: China is a member of the P5+1 negotiating group and is a major energy client for Iran.

The West has dismissed the workability of BRICS. But if 28 countries in NATO could unite to contain Russia, surely the five nations of BRICS can come together to ensure their geo-economic future.

Neelam Deo is a former Indian Ambassador and Director of Gateway House: Indian Council on Global Relations.

Akshay Mathur is Head of Research; Geoeconomics Fellow at Gateway House: Indian Council on Global Relations. 

This article was orginially published in Financial Times here.

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