BRICS – Brazil, Russia, India, China, and South Africa – are the group of five major emerging economies that have been a serious topic of discussion in recent years. These countries have some of the largest populations and have experienced rapid economic growth and increasing global influence over the past decade.
These countries have been engaged in serious talks recently about creating a new BRICS currency. The rationale for this move would be, firstly, to avoid using the US dollar and thereby limiting American geopolitical influence. Another motivation would be to reduce the foreign exchange fees and risks associated with using US dollars for international transactions and domestic investment. Many countries have publicly denounced the US dollar and have committed to becoming less dependent on its influence.
Some commentators doubt that a BRICS currency can be successful. The member nations would have to reckon with differing economic conditions between the BRICS nations including divergent economic performance, unemployment, and inflation rates. Similar challenges have plagued the European member countries using the Euro. Political instability among the BRICS nations may also undermine confidence in and thus demand for the new currency.
Despite the obvious challenges, the BRICS nations continue to build financial infrastructure that could one day support a new global monetary system. For example, in 2015 the BRICS nations established the New Development Bank (NDB) to support infrastructure development in the BRICS nations and other emerging markets. The creation of this new institution represents a noteworthy shift in the international financial system because it represents an alternative to the World Bank. Founded in 1947, the World Bank was created along with the International Monetary Fund as part of the Bretton Woods system which established the US dollar as the global reserve currency.
Although the US dollar is unlikely to be replaced in the short run, businesses should still consider how the creation of a new currency system could affect international trade and future business opportunities.
Shifting exchange rates could change the international playing field
International exchange rates determine the value of one currency relative to another (e.g. USD/CNY exchange rate). These rates can fluctuate rapidly depending on currency demand, trade volumes, interest rates, relative economic performance, and inflation.
Exchange rates are an important factor that can shape global supply chains. When considering whether to offshore production, forecasts about exchange rates can mean the difference between building a factory in a foreign country or scuttling the project altogether. For example, if a business considers offshoring production to China, it must consider how raw materials and other costs of production are likely to change. When the business buys goods from abroad, it must pay in the supplier’s local currency, which means that exchange rate fluctuations can impact costs and profitability.
Shifting exchange rates can also impact consumer demand and the incentive to expand into new markets. If an overseas market has a relatively weak currency, then this will impact consumers’ ability to pay. This would require the business to cut prices or suffer reduced demand, making it more difficult to compete with local competition. In contrast, if a foreign market has a strong currency, then the business’s products will be more affordable for consumers, and so it will be easier to undercut local competition.
If the BRICS currency were to gain widespread acceptance in global trade, this would reduce demand for and thus weaken the US dollar. This might strengthen the competitiveness of the American economy and encourage manufacturers to relocate there. However, at the same time, this might also increase demand for and thus strengthen the BRICS currency. The BRICS nations would thus become more attractive as an export destination and would gain the capacity to command more of the world’s resources. This increased economic dominance would likely go hand in hand with increasing geopolitical influence.
Problems for international business
In the short run, businesses would need to adapt to the new currency regime by making changes to their systems and processes. They would need to ensure that their systems can accommodate the new BRICS currency and that their staff are trained to use it effectively. They would also need to navigate the potential challenges of a multi-currency environment, such as volatile exchange rates and currency risk.
Ultimately, the introduction of a new BRICS currency could drastically change the playing field for international business. It would likely create new opportunities for trade and reduce currency complications between the BRICS nations, which represent a large portion of the world’s GDP. However, it would also pose challenges for other nations that trade with these countries.
If the US dollar were to decline in value, it would make it much more expensive for Americans to import products produced in the BRICS nations. According to the World Trade Organization [pdf], the United States ranks as the world’s second-largest importer, accounting for about 13.5% of global imports. As a result, a weakening of the US dollar would have a major impact on export businesses located outside of America.
Although a weaker US dollar would have the potential to make the American economy more internationally competitive, the adjustment process would be difficult, time consuming, and expensive. Huge amounts of capital would need to be invested to build new production capacity in the Americas just at a time when capital and resources would likely be flowing out of America and into the increasingly dominant BRICS nations. In that kind of scenario, there is no guarantee that America would be able to reinvent itself successfully.
How businesses can prevent losses
In the short run, businesses should focus on managing their exchange rate and currency risk exposure. Effective currency risk management strategies can help businesses to control costs, improve profitability, and minimize the impact of exchange rate fluctuations.
One way to manage exchange rate risk is to negotiate contracts so that they are denominated in a business’s local currency. This shifts risk to the other counterparty. Although this can be an effective way to transfer risk, its feasibility as a risk management strategy depends on a business’s bargaining power with its customers and suppliers. Alternatively, businesses may use financial instruments such as forward contracts or options to reduce currency risk by locking in favorable exchange rates for future sales and purchases.
In the longer run, businesses may need to reorganize their supply chains and reassess target markets to mitigate the potential losses stemming from shifting exchange rates. When exchange rates become unfavourable, it can significantly impact the competitiveness and profitability of an international business. By reorganizing supply chains, businesses can strategically position themselves to minimize exposure to currency risk. This might involve diversifying sourcing locations to include countries with stable currencies or entering into long-term contracts with suppliers that provide more favourable pricing. Furthermore, businesses might need to reassess their target markets and prioritize countries that are likely to benefit from the shifting exchange rate dynamics.
The bottom line
The potential creation of a new BRICS currency system could have a significant impact on international business. The uncertainty surrounding its adoption and the potential instability of member nations’ economies make it difficult to predict the currency’s success. As a result, businesses should proactively manage their exposure to currency risk. With a willingness to adapt to changing market conditions, businesses can position themselves for success in the ever-evolving global economy.
Wes Brooks is an incoming Summer Business Analyst at Cicero Group and an undergraduate studying economics, management, and strategy. He is a serial entrepreneur, works in venture capital, and enjoys singing a capella and piano improvisation.
Image: Pixabay
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