Earlier this year, the Central Bank of Brazil announced an agreement with the People’s Bank of China, enabling direct conversion between their currencies without the need for the intermediary US dollars.
For Brazil’s banks, beyond the gradual fee growth potential associated with this new product, the agreement will result in new offerings such as derivatives and innovative yuan-linked loan models.
“These financial instruments serve as tools to the dynamic landscape engendered by yuan integration. While the short-term impact might be minimal, these measures hold promise for enhancing the long-term profitability of Brazilian banks,” says Claudio Gallina, senior director of financial institutions at Fitch Ratings.
”The macro-level benefits of this transformative measure are clear, including heightened liquidity in yuan, the preservation of dollar foreign reserves within the country, and a streamlined international payment ecosystem with fewer intermediaries,” he notes, adding that the measure alone does not have the power to change ratings of Brazilian banks.
these measures hold promise for enhancing the long-term profitability of Brazilian banks
The arrangement will also result in benefits for companies, particularly importers, in terms of foreign exchange cost reduction.
However, for Brazilian exporters to accept renminbi payments, the Chinese currency would need to be recycled by Brazilian importers purchasing Chinese goods. Brazil’s total imports from China were worth $51bn in 2021, lower than its exports to China.
The Chinese currency has surpassed the euro as the second main currency of Brazil’s international reserves, the country’s central bank said a March report.
Until 2018, the yuan was absent from the country’s foreign reserves, but by the end of 2022 represented 5.37% of the total.
Similar developments in the region
The growing presence of China in Latin America and the Caribbean has been a growing trend over the past two decades, and the country has become the region’s second largest trading partner.
While trades are still settled in dollars, there are signs that things are changing, or at least that there is the political will for change.
In June, for the first time, Argentina met a payment obligation to the International Monetary Fund in yuan. The country has also renewed a three-year currency swap agreement with China to strengthen its reserves and will start to pay for Chinese imports in yuan rather than dollars.
Earlier this year, Brazilian president Luiz Inácio Lula da Silva and his Argentinian counterpart Alberto Fernández shared their plans to create a new currency for the Mercosur trade bloc, which also includes Uruguay and Paraguay.
Another South American president, Luis Arce of Bolivia, has announced that his government is considering the adoption of the yuan as an alternative to the dollar in international trade. The country is facing a dearth of dollar reserves, as previously reported by The Banker.
Increasing de-dollarisation efforts
The increased use of the yuan, or the intention to do so, is part of a broader and much debated de-dollarisation trend, which has been more evident since the start of the war in Ukraine, which saw the US freeze a large part of Russia’s foreign reserves. Russia has in turn declared it will use Chinese yuan to trade with Asia, Africa and Latin America.
The country, along with the other Brics countries Brazil, India, China and South Africa, is also supporting the development of a new currency to be used for cross-border trade by the bloc. The issue would be discussed at the Brics summit in South Africa at the end of August.
A regional bloc currency may cause further reserve fragmentation. The US dollar as a share of global central bank reserves has dropped from 72% in 2002 to 58% in 2022. However, a Brics currency would likely not have enough capital market clout to be a real alternative to the US dollar’s currency reserve status, notes a Goldman Sachs paper.
However, the dollar continues to dominate as a global currency. The renminbi gained market share in functioning as the medium of exchange in global markets, but is still little used in roles of store of value and unit of account globally, according to a July Goldman Sachs note.
The renminbi share of international payments rose from 1.1% at the end of 2013 to 2.5% in May 2023, but the dollar remains the dominant currency in international payments.
While the feasibility of all these de-dollarisation plans is still questioned by some economists, it is clear that the issue will remain on the agenda for the medium term.
