Russia Sanctions: Are China And India Thinking ‘Can This Happen To Us’

Will large EMs finally undertake steps to wean themselves off the U.S. dollar-based global financial system, asks Jim O'Neill.

<div class="paragraphs"><p>The Leaders dialogue with the BRICS Business Council, in Brasilia, Brazil on November 14, 2019. (Photograph: PIB)</p></div>
The Leaders dialogue with the BRICS Business Council, in Brasilia, Brazil on November 14, 2019. (Photograph: PIB)

Every crisis is always different in some way, as to its origin, complexity, and probable solution. What often feels the same, however, is that every truly global crisis often feels like the worst we have all ever experienced, and it may well be, until we are through the worst of it, or we get to the next one. Barely through the worst of Covid-19, itself which has had devastating repercussions for world economic activity, the Russian invasion of Ukraine has brought another one. In this case, the spectre of a massive war emanating and centring around Europe, but with it, the spectre of a massive energy crisis, possibly on a par with anything seen including the 1970s, as well as a global financial crisis.

At the core of solving these problems is trying to stop conflict in Ukraine, which to me, seems only possible with domestic Russian revolt with President Vladimir Putin, or an agreement that he can claim is a victory. Analysis of the solution is not the purpose of this article, I suspect new criteria about future membership of NATO might be the core of it, but I want to focus on the consequences for others of the G7 countries’ announcement to freeze Russia’s central bank reserves held with them.

Does this undermine the whole post-Asian Crisis consensus about the need to hold a war chest of foreign exchange reserves for emerging market countries, and if so, how do they build their defences to protect against the risks of a foreign exchange driven crisis? And beyond this, will this make many—especially larger emerging economies—finally undertake steps to wean themselves and the world off the U.S. dollar-based global financial system?

Will EMs Change Their Approach To Building Large Forex Reserves?

The decision to freeze Russia’s central bank reserves was quite a remarkable step, and almost definitely one that President Putin didn’t anticipate, not least because it renders much of his foreign exchange reserves of little use for the foreseeable future, and together with other steps, undermines the value of the Ruble. With these moves, the likely economic consequences for the Russian economy will be quite dire. It was the case that the huge rise in gas and oil prices would provide some comfort, but steps have now been taken toward decreasing much of the world’s use of Russian energy.

For other countries, especially those not endowed with massive domestic commodities and sources of energy, in particular, the fact that western governments have taken these steps obviously means they could be taken again.
<div class="paragraphs"><p>Storage tanks at the Petrobras Reduc refinery in Rio de Janeiro state, Brazil, on Oct. 21, 2021. (Photographer: Dado Galdieri/Bloomberg)</p></div>

Storage tanks at the Petrobras Reduc refinery in Rio de Janeiro state, Brazil, on Oct. 21, 2021. (Photographer: Dado Galdieri/Bloomberg)

I would imagine that in the not-too-distant future, most western leaders will be at pains to point out that such measures would only be repeated for those countries that are clearly violating existing and accepted international laws. Which might pacify many countries, and probably should, especially smaller populated ones that are unlikely to ever become very large countries in global economic terms. But for some, especially larger countries that have a chance of becoming very large, such as Brazil, India, Indonesia, amongst others, and obviously, China, they might want to really think this through. For China especially, given the issue of Taiwan and other current sources of tension with the United States and western countries, this must give them massive pause for thought. Indeed, I suspect they might be privately furious with Russia’s tactics that have provoked this response, because it might force China to make some decisions that they might have either chosen to do in the future or wait until they made their own choices on their own criteria, not because of another country’s actions.

Looking Beyond The Dominant U.S. Dollar-Based Financial System?

I lose count of the number of articles I have written in recent years, indeed, decades, about the peculiar persisting dominance of the U.S. dollar-based global financial system especially since the U.S. and its G7 allies have seen their collective share of global GDP drop to around 50% of the world’s economy. It doesn’t seem particularly equitable that their financial system with the dollar at the heart of it should play such a dominant role in world finance. But, as I have learnt over this considerable length of time, until others make a conscious effort to allow their own financial systems to become more important, both to themselves and especially to non-residents, it will remain the status quo. And it will allow western policymakers to occasionally undertake the dramatic decisions announced last week.

Chinese intellectuals have sometimes talked about replacing the dollar-based system with one where the Special Drawing Rights play a central role. The SDR is the current accounting system of the IMF that consists of several currencies, including the Chinese renminbi, although not currencies of any other large emerging nation. But quite how that would work without a single global central bank is hard to understand. And how could this be representative for other ambitious large emerging nations such as India and others?

The answer almost definitely lies in whether large emerging economies want to undertake the scale of reforms that makes other countries’ citizens want to hold their currency, especially conservative investors, such as other foreign central banks.
<div class="paragraphs"><p>U.S. one-hundred dollar bills sit with a Chinese one-hundred yuan banknotes, in Hong Kong. (Photographer: Paul Yeung/Bloomberg)</p></div>

U.S. one-hundred dollar bills sit with a Chinese one-hundred yuan banknotes, in Hong Kong. (Photographer: Paul Yeung/Bloomberg)

If we take India as an example, steps that made the rupee more desirable to international investors (beyond devoted specialist emerging market investors) would require people around the world to have much more confidence in the stability of the Indian economy, the reliability of economic policy, and specifically, the ease to be able to buy and sell their Indian assets quite easily and with a lot of liquidity. The circumstances in which this may happen would almost definitely qualify the Rupee to become part of the SDR, as the criteria includes the size of the economy, the importance of its share in global trade, and the use of its currency in financial transactions. And in those circumstances, it is most likely that India would not be so bothered about threats from other countries such as the U.S. as their own domestic markets would be sufficiently credible to attract investors and savers from all over the world, rather than the US Dollar does today. And this would be true for others, whether it be, Brazil, Mexico, Indonesia, Turkey, and especially China.

In the meantime, will they still accumulate foreign exchange reserves at the same pace, or has global FX reserve accumulation peaked? A story for another article!

Jim O'Neill is an economist best known for coining ‘BRIC’, a former Commercial Secretary to the Treasury in the United Kingdom, and former chairman of Goldman Sachs Asset Management.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.