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China and De-dollarization – Part 2 – BRICS and SCO

De-dollarization

Part 2 - BRICS and SCO

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While China is a driving force in the Global South’s pivot away from the USD, the rapid expansion of inter-regional economic organizations made up of Asian, Central Asian, Middle East, African and Latin American countries has accelerated the shift in political and economic power that threatens to upend more than 70 years of US dominance on the world stage.
SINOLOGIX Staff
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2023-04-14
CHINA AND DE-DOLLARIZATION - PART 02

Executive Summary

While China is a driving force  in the Global South’s pivot away from the  USD, the rapid expansion of inter-regional economic organizations made up of Asian, Central Asian, Middle East, African and Latin American countries has accelerated the shift in political and economic power that threatens to upend more than 70 years of US dominance on the world stage.

In Part 1 of this 4-part series, we summarized the key factors that might trigger a future change in currency usage by China and its trading partners.

In this Part 2, we examine the structure and role of emerging regional organizations that seek to break free of what they perceive to be US hegemony, especially as it is exhibited in the global financial system.

In Part 3, we survey the various bilateral and inter-regional trade agreements of the BRICS+ and SCO+ members – as the multi-polar / Global South movement accelerates, not only are an increasing number of trading partners negotiating one-off trade settlement agreements, but there is now a consensus that the time is right for a gold or commodity-backed currency.

And in Part 4, we examine the cascading economic and political impact of the de-dollarization trend, both to the US/G7 bloc and the collective Global South.

Emergence of Inter-Regional Economic Organizations

The rapid expansion of non-G7 organizations made up of Asian, Central Asian, Middle East, African and Latin American countries has launched a profound shift in political and economic power that threatens to upend more than 70 years of US dominance on the world stage. We’re referring to the so-called BRICS+, the Shanghai Cooperation Organization and the Eurasian Economic Union.

The significance of the BRICS+ and SCO is their economic footprint – it now accounts for nearly 32% of the world’s GDP and its members are among the fastest growing economies – by 2050, China’s and India’s combined GDP (measured as purchase power parity) is forecasted to reach $165.9 trillion, compared to the projected $39.7 trillion for the US .

Furthermore, all three organizations are rapidly incorporating new members and coordinating their respective political and economic agendas. It’s worth noting that this expansion is occurring right on the US’ doorstep – Mexico, Nicaragua, and Argentina have recently expressed interest in joining BRICS.

Conclusion

While the entry point for this analysis is the potential for de-dollarization at scale, the trend to a more balanced global financial system is unlikely to result in the demise of the USD in the foreseeable future.  However, there are two important potential consequences of any diversification away from the USD for trade settlement.

First, even a nominal reduction in foreign currency reserves may amplify inflationary pressures on the US Treasury vis-à-vis interest rates. In all candor, we have not evaluated the extent to which domestic buyers of Treasuries will absorb any such reduction in foreign demand. And certainly, there are many other factors that influence this equation. But it’s worth noting that the cost of servicing the US’ $31 trillion debt is already $475 billion – even a minor increase in applicable coupon rates for Treasuries will have a profound effect on government operations.

Second, US foreign policy in the last several decades has increasingly relied on sanctions to coerce governments deemed unfriendly to bend to the will of the US. Those sanctions depend on a tightly integrated global financial system to force countries such as China, Russia, and Iran to comply with US demands. The real risk (to the US) of so-called de-dollarization is that its adversaries are in an increasingly favorable position of being able to circumvent most sanctions. The most conspicuous example of this is the sanctions against Russian oil and gas exports – while there was an initial economic hit (Russian GDP declined by an estimated 2-3% in 2022), export operations have effectively pivoted to eastern markets (Russia’s GDP is expected to grow in 2023). There is a compelling argument that the sanctions have hurt the EU’s economy as much, if not more, than Russia’s.

These two possible outcomes need to be closely monitored. There is a kind of positive feedback loop at play here, whereby heavy-handed US sanctions for what may be perceived as questionable causes encourage members of the collective Global South to think twice about the extent to which they want to tie their fortunes to the traditional global financial system.

The perception of US hegemony, vis-à-vis military interventions in countries such as Libya, Afghanistan, Iraq, Syria, and Ukraine, non-military interventions in countries such as Iran and Venezuela, as well as the proxy effect of the IMF and its notorious “conditionalities”, has alienated a number of countries who have patiently waited for an opportunity where the collective economic and political power of an alternative to NATO and the G7 would present itself. And with the arrival of President Xi in 2013 and his vision for just such a China-led alternative, that moment seems to have arrived.

BRICS

Overview

The BRICS organization (i.e. Brazil, Russia, India, China, and South Africa) has recently emerged as a legitimate geopolitical bloc to challenge the dominance of the G7 countries. Initially conceived as an informal grouping, BRICS has evolved to establish a more formal presence in global politics and economics.

Key Objectives

The original intent behind the creation of the BRICS was to establish a platform for dialogue and cooperation among emerging economies that could counterbalance the influence of the G7 and other western-dominated institutions. The group was initially labeled as BRIC, without South Africa, in a 2001 report by Goldman Sachs economist Jim O’Neill. It was only in 2010 that South Africa joined the group, giving rise to the current BRICS acronym.

In 2006, the first formal meeting of the BRIC nations took place, and the group was formally recognized as a geopolitical bloc by the United Nations General Assembly in 2011. The BRICS Forum, which serves as a platform for annual summits, facilitates dialogue and collaboration among member nations on various issues of mutual interest.

Extended BRICS Membership

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Data Source – World Bank

As of 2023, BRICS membership is still limited to Brazil, Russia, India, China, and South Africa. However, there is growing speculation about the imminent inclusion of other emerging economies, notably Indonesia, Mexico, and Nigeria.

Mexico’s membership could pose a thorny challenge to the US, with whom it is currently experiencing a rocky relationship over immigration and the influence of drug cartels.

Economic Footprint

BRICS nations collectively account for approximately 42% of the world’s population and nearly 32% of global GDP. In recent years, the GDP growth of BRICS countries has outpaced that of G7 nations and the global average, highlighting their growing economic presence in the international arena.

By 2050, it is projected that the combined GDP of China and India, measured as purchasing power parity (PPP), will reach a staggering $165.9 trillion, significantly surpassing the projected $39.7 trillion for the United States. This rapid growth underscores the increasing economic clout of the BRICS nations relative to the G7, and their potential to reshape global economic dynamics in the coming decades.

New Development Bank

In 2014, the BRICS nations established the New Development Bank (NDB), formerly known as the BRICS Development Bank, as a multilateral development bank to finance infrastructure and sustainable development projects in member countries and other developing nations. The NDB, as well as China’s Asian Infrastructure Investment Bank (AIIB), make it possible to sidestep the IMF and its somewhat hegemonic “conditionalities” for loans.

Issues and Challenges

As discussed far more thoroughly by Liu and Papa in their analysis of the BRICS, despite the bloc’s growing influence, it nevertheless faces several challenges that hinder the formation of a cohesive de-dollarization coalition. First, some members, such as India, have stronger relationships with the US than their fellow members (i.e. China and Russia), preventing the adoption of a unified de-dollarization strategy. Second, other BRICS members (i.e. Brazil and South Africa), have less exposure to US sanctions, simply because they pose less of an economic, military or political threat to the US. Consequently, they might not share the same sense of urgency to prioritize de-dollarization efforts. While all BRICS members are interested in reducing their dependence on the US dollar, not all are equally eager to detach from the US-led global financial system. Finally, as of 2021, several BRICS countries still held significant amounts of US dollar assets in their reserves – abruptly dumping those assets on the open market (and the potential impact on the USD’s value) would have the counter-productive effect of reducing the value of their own portfolios (Liu and Papa). Nevertheless, China has reduced its US Treasuries holdings by 48% since 2013, and although Russia’s hand was forced by US sanctions, it has nearly eliminated its portfolio of US Treasuries from an estimated $176 billion in 2010.

Relevance in 2023

Recently, however, there has been a shift in the dynamics within the BRICS group, ironically driven in part by US sanctions against Russia. The following developments are indicative of a more cohesive BRICS bloc:

  • The recent Sino-Russian summit, where Presidents Xi and Putin reinforced their commitment to mutual support and cooperation.
  • China’s defiance of US sanctions by continuing to purchase Russian oil and gas.
  • India’s increased import of Russian oil, despite US pressure.
  • China and Brazil’s agreement to denominate trade in local currencies, bypassing the US dollar.

These actions have confounded US foreign policy and subverted the effectiveness of sanctions against Russia. And increasingly, trade between these five countries is transitioning to local currencies.

Conclusion

The BRICS nations have evolved from an informal grouping of emerging economies to a more cohesive geopolitical bloc that challenges the influence of Western powers. Although internal challenges persist, recent developments indicate that the BRICS countries are increasingly collaborating to counterbalance the dominance of the US dollar and the traditional global financial system. As a result, the role of BRICS in the ongoing “de-dollarization” trend is becoming more pronounced.

Shanghai Cooperation Organization

Overview

The Shanghai Cooperation Organization (SCO) was created as an informal coalition called the Shanghai Five in 1996, and then formally organized under its current name on June 15, 2001. Founding members of the organization included China, Russia, Kazakhstan, Kyrgyzstan, and Tajikistan. Uzbekistan joined the organization as a full member in 2001, further expanding its geographical reach and influence.

Unlike the BRICS model, which initially represented the world’s largest and most powerful emerging economies, the SCO was originally intended to be a regional organization that addressed common security interests of geographically proximate countries. Its goals have since broadened to include military and economic cooperation, and its geographic scope has continued to expand, with additional member states and observer states from the Middle East, Central Asia, and ASEAN countries.

Key Objectives

One of the primary goals of the original organization was resolving destabilizing border disputes, such as the long-standing conflict between China and India, which has persisted for decades. It also aimed to combat terrorism, separatism, and extremism within the region. China has been particularly concerned about the separatist movement in its Xinjiang province, while India has faced ongoing challenges related to terrorism.

Unlike the BRICS organization, which has a more balanced economic footprint among its members, China is the dominant member of the SCO and its priorities have influenced the direction of the organization. Given that most of the current members are proximate to the proposed railways, oil and gas pipelines, and maritime port operations of China’s Belt and Road Initiative, it is not surprising that trade, investment, and economic development have been added to the SCO’s agenda. In concert with China’s recent efforts to reduce its exposure to dollar-denominated trade, the SCO is also implementing programs to settle regional trade in local currencies (see Key Initiatives below).

During the 2000 summit in Tajikistan, the SCO approved organizing principles emphasizing non-interference in the internal affairs of its members. The principles included opposing intervention in other countries’ internal affairs on the grounds of humanitarianism and protecting human rights. The member states also agreed to support each other in safeguarding national independence, sovereignty, territorial integrity, and social stability. This approach aligns with China’s long-standing foreign policy of non-interference in the domestic affairs of its trading partners and its insistence that other countries, notably the US, not interfere with its internal affairs, such as those related to Xinjiang, Taiwan, and Hong Kong.

Extended SCO Membership

(swipe on column 2 to scroll table)

Data Source – World Bank

The SCO initially consisted of six charter members: China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan. Since then, the organization has expanded its membership to include India and Pakistan, who became full members in 2017. There are also several observer states: Afghanistan, Belarus, Iran, and Mongolia, as well as dialogue partners such as Armenia, Azerbaijan, Cambodia, Nepal, Sri Lanka, and Turkey.

Iran

Of the observer states, who are in the process of applying to become full members, Iran is the most significant. In 2021, it formally applied for full membership, which has been supported by Russia and China.

Iran’s strategic location at the intersection of the Middle East, Central Asia, and South Asia enhances its importance to the SCO. Joining the organization would strengthen regional connectivity and provide access to Iran’s transportation and energy infrastructure.

Trade between Iran and SCO countries reached $38 billion by 2021, suggesting potential for further economic integration. Membership would provide Iran access to new markets and investment opportunities, while SCO countries would gain access to Iran’s energy resources.

Iran and the SCO share concerns about terrorism, extremism, and separatism. Membership would allow Iran to collaborate with other countries on counterterrorism efforts and contribute to regional stability. The recent agreement between Iran and Saudi Arabia to resume diplomatic relations underscores the importance of Iran’s role in regional stability.

Iran’s membership in the SCO would be strategically important for multiple parties:

  • The SCO would enable Iran to circumvent US sanctions by trading through other SCO members. This would further subverts US foreign policy in the Middle East.
  • Integrating Iran into the SCO would facilitate the build-out of the North-South Transport Corridor, which would in turn enable Russia to circumvent US sanctions on its energy products exports (see below).
  • Iran’s membership in the SCO would reinforce President Xi’s BRI initiative, as it would provide a streamlined maritime-overland route between China and Central Asian/European markets.

Economic Footprint

As of 2021, the combined population of SCO member states was approximately 3.2 billion people, or 42% of the world’s total population. The combined GDP of SCO member states was around $19.5 trillion, accounting for approximately 26% of global GDP. When all of the candidate members are included, the SCO’s share of global GDP is approximately 32.5%.

China’s Economic Agenda for the Region

China wants to promote regional cooperation and development among the SCO member countries.

A critical component of China’s economic agenda within the SCO is access to the vast energy and mineral resources in the so-called ”-stan” countries. Energy and natural resources play a crucial role in China’s economic strategy:

  • China’s imports from Russia grew by nearly 49% in 2022, reaching $110.9 billion.
  • Between 2005 and 2020, Chinese companies invested nearly US$50 billion in Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan.
  • In 2021, China imported 4 trillion tons of natural gas from Kazakhstan.
  • In 2022, China signed an agreement with the Taliban to build out Afghanistan’s oil production infrastructure, an estimated $540 million investment, the largest by a foreign country since the Taliban takeover of the government in 2021.
  • In 2023, Chinese companies proposed a $10B investment to build out lithium mining in Afghanistan, which has an estimated $1 to $3 trillion in untapped lithium deposits.

Conclusion

While the BRICS is a coalition of the largest emerging economies in the Global South, the SCO’s current power structure is a bit more asymmetrical – China is the dominant economy within the organization.

The US’ withdrawal from Afghanistan in August 2021 left a gaping hole in its ability to project both military and soft power in Central Asia. During its 20-year occupation of Afghanistan, the USGS conducted extensive surveys in Afghanistan and concluded it potentially is the “Saudi Arabia off lithium” and other key mineral resources.  As has happened in other countries where US foreign policy has waned, China has stepped in to fill the power vacuum and is likely to become Afghanistan’s dominant trading partner. This not only gives China further control over global lithium supplies, but also is a conspicuous reminder that its pragmatic foreign policy is more cost effective and stable than the US model of military occupation.

To the extent that the SCO’s expansion is extended to include the Mid East countries of Saudi Arabia, Qatar, Egypt, and Turkiye (all of whom have expressed interest in joining the SCO). China’s influence model in what has traditionally been the domain of the US and the UK is likely to accelerate. President Xi’s recent success in negotiating resumption of diplomatic ties between Saudi Arabia and Iran only underscores the importance China attaches to asserting it presence on the world stage – and it further underscores the extent to which these countries accept such a role.

Other Inter-regional Organizations

European Asian Economic Union

In the context of de-dollarization, the Eurasian Economic Union (EAEU) is not nearly as important as the BRICS or the SCO. But from the perspective of US foreign policy and the declining effectiveness of sanctions against Russia and Iran, it is worth briefly this organization and the North-South Transport Corridor, which traverses its member countries.

The EAEU is an economic and political union created to establish  a single economic market across the former Soviet Union, promoting economic development, and ensuring the free movement of goods, services, capital, and labor among its member countries.

Its foundation was established in 2011 with the signing of the Treaty on the Eurasian Economic Commission. The formal formation of the EAEU took place in 2015, following the ratification of the Treaty on the Eurasian Economic Union by the participating countries – Russia, Belarus, Kazakhstan, Armenia, and Kyrgyzstan.

Ukraine, which had applied for observer status in the EAEU in 2013, saw its relationship with the organization change dramatically following the Maidan Revolution in 2014. The new Ukrainian government opted for closer ties with the European Union, leading to a suspension of its observer status application.

Uzbekistan, another important regional player, has remained cautious about joining the EAEU. While it has expressed interest in strengthening economic cooperation with the organization, it has not pursued full membership, citing concerns about its sovereignty and the potential impact on its domestic economy.

Iran, on the other hand, has not applied for membership in the EAEU but has signed trade agreements with the organization. These agreements aim to facilitate trade between Iran and EAEU member countries, although they do not signal Iran’s intention to become a full member of the union.

North-South Transport Corridor

Map of North-South Transport Corridor
Image - MapTiler
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North-South Transport Corridor

The North-South Transport Corridor (NSTC) is a significant multinational infrastructure project not sponsored by the EAEU per se, but relevant because it traverses Russia, Azerbaijan, and Iran, linking Russia with India and Asian markets. The NSTC is introduced here due to its importance to Russia’s ability to circumvent US sanctions and China’s capacity to expand its Belt and Road Initiative (BRI) further.

The NSTC project was initiated in 2000 when Russia, India, and Iran signed an agreement to develop it. The primary goal was to establish an efficient, multimodal transportation corridor connecting Russia with India, bypassing the traditional sea route through the Suez Canal. The NSTC has since expanded to include other countries such as Azerbaijan, Armenia, Kazakhstan, Kyrgyzstan, Tajikistan, Turkey, Ukraine, and Belarus.

Significance

The NSTC offers a direct corridor between Russia, India, and other Asian markets, shortening transportation times and reducing costs compared to the conventional maritime route. By using a combination of rail, road, and sea transportation, the NSTC aims to provide a faster and more reliable route for the movement of goods between these countries.

Moreover, the NSTC has strategic implications for Russia and China:

For Russia, it serves as a way to bypass US sanctions on its energy exports by providing an alternative route to access markets in India and Asia. It also enables Russia to strengthen its economic ties with these regions, reducing its reliance on the West.

For China, the NSTC complements its BRI, which aims to connect Asia, Europe, and Africa through a network of infrastructure projects. By integrating the NSTC into its broader BRI framework, China can further expand its economic influence in the region and enhance its connectivity with Russia, India, and other countries along the corridor.

Issues

Despite the potential benefits of the NSTC, the project has faced several challenges that have slowed its progress, including:

Financial Constraints: The project requires significant investment in infrastructure development, for which funding has been difficult, given the economic challenges faced by the participating countries.

Geopolitical Tensions: The NSTC passes through regions with complex political dynamics, such as the South Caucasus and the Caspian Sea, which have been the focus of long-standing territorial disputes and rivalries.

Sanctions: US sanctions on Iran and Russia have complicated the project’s implementation, as they limit access to international financing.

NOTES

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Works Referenced

Liu, Zongyuan, and Mihaela Papa. “Can BRICS De-Dollarize the Global Financial System?” Cambridge Core, Cambridge University Press, 24 Feb. 2022, https://www.cambridge.org/core/elements/can-brics-dedollarize-the-global-financial-system/0AEF98D2F232072409E9556620AE09B0.

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"Things change gradually at first...

...then all at once..."

China GDP vs UST Holdings (2010-22) (billions)

(click/tap legend to filter data)
China GDP vs UST Holdings (2010-22) (billions)

Data Source – World Bank

Global FX Exchange Reserves (2001-22) (% of total)

(click/tap legend to filter data)
Global FX Exchange Reserves (2001-22) (% of total)

Data Source – World Bank

Global FX Exchange Reserves (2001-22) (% of total)

(click/tap legend to filter data)
Global FX Exchange Reserves (2001-22) (% of total)

Data Source – World Bank

Western media is starting to pay attention to China’s efforts to influence members of the so-called Global South, or more specifically the BRICS+ and Shanghai Cooperation Organization (with substantially overlapping membership), to denominate international trade in the Chinese Renminbi (RMB), aks the Chinese Yuan (CNY) and/or other local currencies. For very different reasons, Russia has promoted the idea of an entirely new currency for trade settlement. This is an accelerating trend among countries that have formed close economic and political relationships with China.

Coincident with the pivot to the RMB for trade settlement is a growing sentiment among the BRICS+ and SCO members that holding USD as their primary reserve currency poses a risk in the event the US declares sanctions and/or freezes a country’s assets, as happened with Russia and Belarus in 2022.  

The combined effect of these two trends should be observable in a country’s US Treasuries holdings, and that’s exactly what we’re seeing in the chart above – China’s USD and Treasuries holdings peaked at $1.277 trillion in 2013 and declined by more than 32% in 2022.

Things change “slowly at first, then all at once”...

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