From Great Depression to Great Recession

Chapter 7. Hurling BRICS at the International Monetary System

Atish Ghosh, and Mahvash Qureshi
Published Date:
March 2017
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Benn Steil

In April 2013 Ukraine was facing a massive current account deficit of 8 percent and was badly in need of dollars to pay for vital imports. Yet on April 10 President Viktor Yanukovych’s government rejected terms set by the International Monetary Fund for a $15 billion financial assistance package, choosing instead to continue financing the gap between Ukraine’s domestic production and its much higher consumption by borrowing dollars privately from abroad. On April 12 Kiev issued a 10-year, $1.25 billion Eurobond that cash-flush foreign investors gobbled up at a 7.5 percent yield.

Everything seemed to be going swimmingly until, on May 22, the Federal Reserve’s chairman Ben Bernanke suggested that the Federal Reserve might, if the economy continued improving, begin to pare back or “taper” its monthly purchases of US Treasury and mortgage-backed securities. This would mean more attractive returns on longer-maturity US bonds, making financial assets of developing markets decidedly less attractive. Investors in Ukrainian bonds reacted savagely, dumping them and thus raising their yield to about 11 percent—where it stayed for most of the remainder of the year (Figure 7.1).

Figure 7.1.Ukraine: Seven-Year Government Bond Yield


Source: Bloomberg L.P.

Ukraine’s financial problems had been growing over many years, but it was the prospect of the Federal Reserve pumping fewer new dollars into the market each month that pushed the cost of rolling over its debt beyond Kiev’s capacity to pay. Ultimately, in December, President Yanukovych turned for help to Moscow, which demanded that he abandon an association and trade agreement with the European Union in return. Ukrainians took to the streets … and the rest is history.

The Federal Reserve did not actually begin its taper until January 2014, and it is sobering to contemplate that this history might have been much different—President Yanukovych might have remained in power—had Ben Bernanke’s taper talk come a few months later than it did. Such is the global power of the Federal Reserve.

Ukraine was only one of many developing nations that suffered massive sell-offs in their bond and currency markets following the taper talk. The selling was not indiscriminate, however. The countries hit hardest—Brazil, India, Indonesia, South Africa, and Turkey—had all been running large current account deficits, which had to be financed with imported capital. Their markets recovered modestly following the Federal Reserve’s unexpected decision in September to delay the taper, but swooned again in December when the Federal Reserve announced that it would move forward with its plans. Figure 7.2 shows that there has generally been little improvement in these countries’ current account balances since 2013, suggesting that they are vulnerable in the future to a “rate ruckus”—a bond sell-off triggered by an unexpectedly aggressive Federal Reserve rate increase.

Figure 7.2.Emerging Market Bond Yields and Current Account Balances, 2013

Source: Author’s estimates based on Bloomberg L.P. and IMF staff.

Note: Ukraine data are for the seven-year government bond, and Brazil’s September 17, 2013, data reflect the nine-year government bond yield (panel 1).

As their markets tanked, many leaders of the worst-hit countries criticized Washington for its selfishness and tunnel vision. “International monetary cooperation has broken down,” said Reserve Bank of India Governor Raghuram Rajan angrily, following another sell-off in his country’s currency and bond markets in January 2014. The Federal Reserve and others in the rich world, he said, can’t just “wash their hands off and say, we’ll do what we need and you do the adjustment.”1

To understand what Rajan had expected from the Federal Reserve and why he was so angry, the recently released transcripts of the October 2008 Federal Open Market Committee meeting are illuminating. The transcripts show that members were acutely aware of the global nature of the growing crisis; however, they were not focused on stopping its spread through emerging markets generally but on limiting blowback into the United States. Members agreed that swap lines with emerging market central banks (to lend them dollars against their own currency as collateral) should be temporary and limited to large countries that were important to the US financial system: Brazil, Korea, Mexico, and Singapore, all of which could potentially spread their problems directly into American markets. For example, former Federal Reserve Governor Donald Kohn expressed concern about the potential for large-scale foreign selling of Fannie Mae and Freddie Mac mortgage-backed securities “feed[ing] back on our mortgage markets” and pushing up borrowing rates. Certain countries might go down that route, he argued, if they lacked less disruptive means of accessing dollars, like Federal Reserve swap lines. And “it would not be in our interest” for them to do so, Kohn observed.

The Federal Reserve privately rebuffed swap line requests from Chile, the Dominican Republic, Indonesia, and Peru. And two years later, when the US economy had become much less vulnerable to foreign financial instability, the Federal Reserve allowed its swap lines with Brazil, Korea, Mexico, and Singapore to expire. Two years after that, in 2012, the Federal Reserve denied a swap line request from India, which explains Rajan’s anger. Yet it is unrealistic to expect the Federal Reserve to act differently, however desirable that might have been for other countries. The Federal Reserve’s primary objectives—ensuring domestic price stability and maximum employment—are set by law, and it is not authorized to subordinate them to foreign concerns.

But can’t developing countries take actions on their own to protect themselves, without cooperation from the United States? Indeed they can. The IMF (2013) concluded that countries whose economies have been more resilient in the face of unconventional US monetary policy since 2010 have three important characteristics: low foreign ownership of domestic assets, a trade surplus, and large foreign exchange reserves. These findings have clear policy implications: in good times, emerging markets should keep their imports and currency down, and exports and dollar reserves up.

Unfortunately, many members of the US Congress see such policies as unfair currency manipulation, harming US exporters. To prevent foreign governments from taking such steps, some influential economists such as Fred Bergsten, supported by major US corporations, have called on the White House to insert provisions against currency manipulation into future trade agreements. Others, such as economists Jared Bernstein and Dean Baker (2012), have gone so far as to call on Washington to impose taxes on foreign holdings of US Treasuries and slap tariffs on imports from alleged manipulators.2

These suggestions are misguided; they would only raise global trade tensions and political conflict. But the very fact that prominent commentators are calling for such actions illustrates how the functioning—or malfunctioning—of the global financial and monetary system can encourage a spiral of damaging policy actions.

Given the trajectory of US policy, the turmoil in emerging market currency and bond markets over recent years should spur more effective collective action to defend the global financial system against future Federal Reserve–induced whiplash. Most emerging market countries lack the resources to protect themselves individually, but they could build sufficient currency reserves if they acted in concert. In Asia, for example, the Chiang Mai Initiative Multilateralization of 2010 allows the 13 nations involved to tap their $240 billion of combined reserves in the event of a balance of payments crisis.

Unfortunately, however, there is much less here than meets the eye. The Chiang Mai countries have not actually pooled the funds they have pledged, and members can access significant funds only if they are under an IMF program and subject to stigmatized IMF surveillance and conditionality. In reality, governments in the region are hesitant to extend credit to each other during a crisis, which is the only time it is actually needed. Chiang Mai has yet to commit a penny to mutual assistance and appears unlikely to do so in the future.

In 2014, the BRICS countries (Brazil, Russia, India, China, and South Africa) established a Contingent Reserve Arrangement (CRA) that could play a similar role. Russian President Vladimir Putin said that the CRA “creates the foundation for an effective protection of our economies from a crisis in financial markets.” But does it? Is it a potential substitute for the IMF?

Clearly not, as illustrated in Figure 7.3. Under the CRA, Brazil and Russia could borrow a maximum of about $5.4 billion without being on an IMF program. To put this in perspective, the IMF approved lending to Russia of about $38 billion in the 1990s. In 2002 alone, it approved a 15-month standby credit arrangement for Brazil of about $30 billion. Net private financial flows to emerging markets today are roughly 10 times what they were in 2002, meaning that the size of the loans necessary to address balance of payments financing problems would be even larger now. The BRICS countries know this, which is why individually they hold reserves well over 50 times what they could borrow under the CRA. In fact, tapping the CRA would make a crisis more rather than less likely, as it would signal to the markets that a crisis—which the CRA is institutionally incapable of combating—is in the offing.

Figure 7.3.BRICS: IMF Disbursement and CRA Borrowing

Sources: Banco Central do Brasil; Central Bank of Russia; Reserve Bank of India; People’s Bank of China; South African Reserve Bank; and IMF staff.

Note: BRICS = Brazil, Russia, India, China, and South Africa; CRA = Contingent Reserve Arrangement.

Of the BRICS bank initiative, President Putin said, “the international monetary system . . . depends a lot on the US dollar, or, to be precise, on the monetary and financial policy of the US authorities: the BRICS countries want to change this.” But it is notable that the entire paid-in capital stock of the BRICS bank is in US dollars, whereas only 10 percent of the World Bank’s paid-in capital was contributed in US dollars. So, far from making the world less dollar-dependent, the BRICS bank has actually created a significant new source of demand for dollar-denominated financial assets.

The clear limitations of the Chiang Mai, CRA, and BRICS bank initiatives suggest that it is as easy to bemoan a lack of US financial leadership as it is difficult to find a substitute for it, even when the resources required to do so are readily available. Self-help in the form of large dollar reserves with backup support from the IMF will therefore continue to be essential for developing nations as they try to cope with the vicissitudes of the dollar-dominated global monetary and financial architecture.


    International Monetary Fund (IMF). 2013. “Global Impact and Challenges of Unconventional Monetary Policies.” Policy PaperInternational Monetary FundWashington, DCOctober7.

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1Financial Times, January 30, 2014, “Emerging Markets in Retreat: India’s Raghuram Rajan Hits Out at Unco-ordinated Global Policy” (
2The New York Times, November 6, 2012. “Taking Aim at the Wrong Deficit.”

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