Currency Localisation Set to Doost Egypt as Part of Brics’ New Development Bank

By Nicholas Shubitz

Egypt is set to join the New Development Bank (NDB) after the country’s parliament ratified the accession agreement last month. The bank’s founding members — Brazil, Russia, India, China and SA — have already been joined by Bangladesh and the UAE. Uruguay, and now Egypt, are provisional members. This may serve as a precursor to Egypt joining the Brics bloc and the development of a new global financial system.

High levels of pandemic stimulus-induced inflation have been worsened by the war in Ukraine, and countries such as Egypt have been hit particularly hard. Before the conflict 85% of Egypt’s grain imports were from either Russia or Ukraine. Forced to adopt a floating exchange rate to secure a $3bn bailout from the IMF, the Egyptian pound has come under severe pressure. The declining currency is increasing import costs and eroding the country’s foreign exchange reserves.

The Egyptians are not alone. Many nations are suffering from inflation-induced economic instability worsened by having to service debts and pay for imports with foreign currency. As such, currency localisation is a primary objective for Brics, and alternative sources of development finance such as the New Development Bank could play a crucial role in helping the Brics and other emerging market economies achieve increased financial stability.

While the Brics grouping has enjoyed moderate success with academic exchanges and improved intergovernmental co-operation between the world’s biggest emerging market economies, the formation of the New Development Bank is undoubtedly the group’s greatest achievement. India proposed the formation of the bank in 2012, and a $100bn reserve currency pool was approved by the Brics nations. Headquartered in Shanghai, the bank has disbursed tens of billions of dollar towards infrastructure development projects and emergency relief since 2017.

The bank has an impeccable track record, with multiple AAA ratings (better than any individual Brics country). After Russia’s intervention in Ukraine, Fitch downgraded the NDB’s credit rating from AA+ to AA with a negative outlook due to uncertainty about how this geopolitical event might affect a new lender with big ties to Russia. But the bank’s governors have made credible arguments that the downgrade was unjustified. The NDB immediately suspended financing for any new projects in Russia after the invasion and its balance sheet remains unaffected by events in Ukraine.

While the World Bank and IMF are still the world’s predominant creditors to governments, the New Development Bank is expanding and innovating. For example, the lender is steadily increasing the volume of credit it provides in debtor country currencies. This is a profound departure from the mostly dollar-denominated debt that dominates development finance.

Governments often become entangled in the strings attached to IMF loans. While the NDB does not attach budgetary and public policy conditions to its loans, the IMF often demands austerity and privatisation in exchange for bailouts. Perhaps well intentioned, austerity can precipitate deeper recessions and make it even more difficult for debtor nations to repay their loans. As debt-servicing costs take up a greater share of the budget there is less funding available for the spending that alleviates poverty, such as on food and fuel subsidies, healthcare and education.

Issuing loans in local currencies benefits debtor and creditor by reducing the risk of default due to currency depreciation. This is a big issue for many governments struggling to pay back loans taken out during the pandemic as the US dollar appreciates in response to rising US interest rates.

Debt distress

As more loans are issued in domestic currencies and trade settlements follow, it will ease pressure on emerging market currencies. Stronger currencies mean lower inflation and lower debt-servicing costs. It could also reduce the risk of a country depleting its foreign exchange reserves. As recently with Sri Lanka, running out of foreign currency can precipitate an economic crisis as the country can no longer pay for imports.

Egypt risks facing a similar crisis. The country’s import costs are increasing due to global inflation. This has led to a decline in Egypt’s foreign exchange reserves, necessitating a bailout from the IMF that has seen the Egyptian pound plunge to a record low. As the currency declines it pushes up the cost of imports even further. It is a vicious cycle. According to estimates from the World Bank and IMF, 55%-60% of the world’s poorest countries are close to or already in debt distress, with emerging market debt-to-GDP ratios having risen from 65% in 1980 to more than 250% now.

The need for dedollarised trade and development finance is becoming obvious. If Egypt and other emerging market economies could finance debts and imports in their own currencies, this would undoubtedly help increase global financial stability. Currency localisation in trade and credit would reduce the risk of sovereign defaults and allow countries to better preserve their foreign exchange reserves to defend their currencies.

While there is a long way to go before this becomes the norm, the expansion of the New Development Bank and its local currency loans offer a promising start.

Shubitz is an independent Brics analyst.

BusinessDay

Source: www.businesslive.co.za