GAD

Global Affairs Desk

Tue Jun 18 2024

De-dollarisation of the Global Financial System

~ By Aarush Joshi on 10/13/2023

De-dollarisation of the Global Financial System

The US dollar has gained the status of being the world’s primary currency reserve. It is also the world’s most widely used currency for international transactions, for trade etc. However, its status of being the hegemonic currency in the global financial system is in question, particularly in light of the Russia-Ukraine War. “The risk of de-dollarisation, which is a periodically recurrent theme throughout post-war history, has returned into focus due to geopolitical and geostrategic shifts,” said Alexander Wise, who covers Strategic Research at J.P. Morgan.

To highlight the particulars, certain countries have become increasingly weary of being too dependent on the US dollar, in light of the country’s sanctions on Russia. To add to this de-dollarisation, rising interest rates in developing countries and emerging economies have led countries to trade in other currencies. In July 2023, Bolivia became the latest country, after its South American neighbours- Brazil and Argentina resorted to paying for imports using the Chinese currency.

De-dollarisation simply means moving away from the world’s reliance on the hegemony of the US Dollar. The Dollar has remained the primary reserve currency for international transactions ever since the United States emerged as the world’s top economic power following the lapse of World War 2. For the better part of the 20th century, the US dollar has enjoyed the primacy of being the world’s top reserve currency, held by the central banks of several countries to store value and conduct international business. According to data from the International Monetary Fund, the USD accounted for 59% of allocated currency reserves as of the first quarter of 2023, well ahead of the euro at just under 20% and the Japanese Yen at around 5%.

However, it’s a useful reminder that the Dollar continues to remain at the helm of global transactions, but it has seen a considerable decline in its share of allocated currency reserves since 2001 when it was more than 70%. This decrease has led some experts to question whether we may be experiencing de-dollarisation—a reduction in the world’s reliance on the dollar as its primary reserve currency.

There are two scenarios that could undermine the dollar’s dominance. The first one includes events that could undermine the perceived safety and stability of the US dollar and the standing of the US on the international stage as the dominant power in terms of economy, politics and military. Also, increased polarisation in the political apparatus of the US could undermine the perceived notion of stability.

The second development comes from outside the boundaries of the country and is concerned with the positive trend vis-à-vis developments of other currencies such as economic and political developments in China, the rise of India and transactions which have bypassed the use of the US dollar such as that between India and Russia.

Countries that aim to bypass the dominance of the dollar may adopt various approaches. For this purpose, central banks need an alternate reserve currency that allows them to shop up their local financial system and participate in international trade. Certain alternatives to the dollar could include the euro, yen, rupee etc. As the IMF notes, these currencies haven’t increased their share of reserve allocations in proportion to the dollar’s decline.

Another alternative for central banks is to hold their reserves in gold, something which countries around the world have been doing for quite some time. According to the World Gold Council, central bank demand for gold in 2022 soared to 1,136 metric tons, up 152% year over year and hitting the highest level since 1950.

As stated earlier, the US dollar continues to maintain its position of primacy as the global financial currency. But the trend of de-dollarisation is gathering steam. Discussion of de-dollarisation has intensified because of the war in Ukraine. As the U.S. aims to inflict financial wounds on Russia with sanctions and by freezing Russia’s currency reserves, the punitive power of the dollar is on display. This may be motivating other countries to look for ways around the U.S. currency. Beyond shifting their reserves to gold or other currencies, countries are reducing their dollar dependency by sidestepping the U.S. currency in their international transactions. The Reserve Bank of India has been making efforts to keep the Indian rupee stable and cut down the use of the US dollar. This initiative has seen an earnest beginning with the central bank now allowing invoicing of international trade in Rupees.

This initiative will help reduce India's dependency on US dollars. Experts suggest that while this decision won’t have a considerable short-term impact, it will benefit the country in the long term.

“We see little impact on USD INR value over the short to medium term. Over the long term, it will shift some demand into Rupees from USD. But the impact of that USDINR will be very gradual,” Anindya Banerjee, VP, of currency and interest rate derivatives at Kotak Securities informed in a briefing.

According to trade data, India's imports amounted to $2.5 billion from Russia in April and May, which annualises to $30 billion. Experts suggest it could increase to as much as $36 billion annually. In the best-case scenario, if India pays for all of its Russian imports in rupees, it would save close to $30-36 billion in dollar outflows.

Therefore, it can be concluded that while de-dollarisation continues to gather steam, the hegemony of the US dollar is here to stay for a while. However, history and the contemporary geopolitical happenings of the world suggest that the dominance of the US dollar is fast eroding.

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