The Rewiring of the Global Economy, Central Reserve Bank of Peru, 15th Annual Conference, Cusco 19 July 2024, prepared remarks
Dear conference participants
I'm delighted for the opportunity to speak to you and to be back in Cusco and am most grateful to the organisers for the invitation. In my brief introductory remarks, I would like to offer an idea about a regional payments initiative for Latin America based on central bank digital currencies (CBDC) following similar regional initiatives in Europe and in Asia. It could offer a new approach to assess possible trajectories towards greater use of local currencies and financial and economic integration in the region.
I shall disclose that my focus on Latin America is not random. I had my first job with the U.N. Economic Commission for Latin America (CEPAL) and worked on several Latin American countries during my time at the International Monetary Fund (IMF).
To start, many of you will of course know, we are celebrating the 80-year anniversary of the Bretton Woods conference that took place on 1-22 July 1944. The conference was about establishing the IMF as a framework for economic policy coordination, reigniting international trade to advance international economic integration. The purpose of the IMF was also to establish a multilateral payment system with the aim to use any currency to conduct international payments and avoid the risk of currencies becoming “scarce” as it was put at the time.
19 out of the 45 participant countries at the conference were from Latin America. No region had more countries present at Bretton Woods. And yet, it has not quite brought the level of cooperation and integration to the region, the spirit of the conference intended to produce.
Latin America does not trade very much with itself or invests in itself. Its currencies play almost no role in international transactions. It may make Latin America depend unduly on third countries, thereby being vulnerable to adverse geopolitical shocks and constrain the growth potential and relative attractiveness of the region.
Intra-regional goods trade in Latin America makes up 16 percent of total trade and has been declining from a local high until picking up a little bit recently. Latin America’s intraregional portfolio investments, using as proxy Argentina, Brazil, Chile, Colombia, Mexico and Peru, make up 5 percent and intraregional foreign direct investment only 3 percent.
This may have many reasons. One could be that it is difficult to move money around in Latin America. If moving money around is difficult and if the monies being used are mostly foreign monies, it may impose undue disincentives to seek greater regional integration.
Foreign exchange markets represent naturally a critical reference to denote interest in a national currency. Many if not most financial transactions have a foreign currency element directly or indirectly. The foreign exchange market is characterised by the dominance of a small set of currencies. In 9 out of 10 foreign exchange transaction, by which one currency is exchanged for another at a given exchange rate, the U.S. dollar represents one leg.
Latin American currencies are not widely traded. The Mexican peso is the only currency from the region that can be settled through CLS Bank, the dominant platform for the settlement of the main currency pairs. This greatly reduces prospects for Latin American currencies to be used in international transactions.
While there had been some incipient increase in the volume of transactions involving Latin American currencies, interest has been receding during the last decade. Meanwhile, East and South Asian currencies during the same period have seen some considerable progress.
The adoption of East and South Asian currencies has been accompanied by a significant increase, though from a very low level, of central banks willing to hold Asian currencies. It signals a firm commitment by central banks that they share an interest in the proliferation of new currencies and help advance establishing needed liquidity conditions to make trading in these currencies attractive. Naturally, liquidity in a currency depends on the propensity to hold it. Latin American central banks have maintained very narrow foreign exchange reserve holdings and shunned securities from the region.
Hence, I would like to outline an idea for a new project to advance international payments integration in Latin America using CBDC. This could be an mBridge for Latin America though it should probably be based on a different platform approach. mBridge is a BIS-led CBDC project with the participation of China, Hong Kong, Thailand, UAE and recently Saudi Arabia to offer CBDC to commercial banks as settlement medium for cross-border transactions to strengthen cross-border payments in local currencies.
Despite early forays with Uruguay testing an e-peso, Mexico is now party to new IIF-led CBDC project Agora and Brazil is known to have been experimenting with CBDC for some time including through project Drex, actual or near implementation of a retail CBDC in the Bahamas and the Eastern Caribbean, there is no regional CBDC initiative in Latin America.
CBDC shall denote here a digital representation of central bank money issued on a blockchain in a token format. It is to extend reach of central bank money to serve on alternative financial market infrastructures. Blockchain would extend existing financial infrastructures offering a low-cost alternative and critical interface with the emerging token economies.
Blockchain-enabled platforms offer efficient post-trade settlement without recourse to the large network effects and high concentration that underpin conventional foreign currency settlement arrangements. This should allow smaller currencies to become more attractive.
The region’s central banks could collectively engage to offer new settlement channels for commercial banks using CBDC for interbank clearing and settlement of foreign exchange. It could be deployed on a public blockchain to leverage the resources and innovation of those platforms while employing innovative layer 2 approaches to increase speed and preserve privacy. Commercial banks would obtain CBDCs from their home central banks against reserves. They could settle their obligations outright in central bank money, that is, a direct transfer of principal, allowing non-resident institutions from the point of view of the issuing central bank to hold the home CBDC. The platform would be making available the CBDCs of the participant central banks to all commercial banks.
Foreign exchange rates would rest as today on market quotes. Commercial banks would agree on a given exchange rate as per existing practice and settle with CBDCs by exchanging the respective currency legs in an instant and atomic transaction, that is, both legs of the transaction have to succeed or none does, eliminating credit, counterparty and settlement risk.
The use of CBDC advances new incentives to seek local currency settlement arrangement. It could serve as clearing layer for transactions based on digital bank monies like tokenised deposits. Existing regulation should be sufficient and treat CBDC as foreign currency while trading parties would have to agree bilaterally on the terms of settlement.
Participating central banks should be willing to hold CBDC from other central banks of the region to act as supplier or buyer of last resort, provide needed marginal liquidity and give comfort to commercial banks that they can unwind unwanted foreign exchange CBDC positions. This would signal forcefully that central banks have a stake in promoting greater currency diversification in the region.
To conclude, CBDC has brought a new thinking and new approaches to cross-border and foreign exchange settlement. It could act as catalyst to promote the use of local currencies and attain greater diversification in the international monetary system. This would reduce undue reliance on a very small set of currencies and help shift the relative attractiveness of currencies enhancing choice and resilience in international payments.
While the Bretton Woods spirit of cooperation may not quite have infused Latin America as it had Europe and now seeming increasingly Asia, a regional CBDC initiative may help offer a new perspective about the future of payments integration in Latin America.
Thank you for your attention.