Geostrategic Media Political Commentary, Analysis, Security, Defense
For Gulf states, balancing the use of the dollar and the renminbi will become a way of maintaining strategic neutrality amid global geopolitical fragmentation.
As China’s geo-economic influence expands across the Middle East and North Africa (MENA), countries in the region are becoming acutely aware of the risks emanating from their dependence on the U.S. dollar. From a ground-breaking Chinese Renminbi (RMB)-denominated energy deal to the recent integration of four Middle Eastern countries into BRICS+—which advocates for the expanded use of local currencies, the MENA region is riding the wave of de-dollarization. However, the RMB will not become a credible alternative in the near future. Instead, the currency forms part of MENA countries’ financial toolkit to safeguard their long-term economic interests.
While China’s strides across trade, investments, and the digital landscape encourage the adoption of the RMB, the dollar maintains a significant international role in all three functions of money—as a unit of account, a medium of exchange, and a store of value. It makes up nearly 90 percent of foreign exchange transactions, half of the invoice currency of global trade, and half of all cross-border loans and international debt securities. Additionally, the dollar offers several advantages. It is a widely accepted medium of exchange that lowers international transaction costs. When adopted in unstable economic and financial environments, the dollar can also provide greater currency stability relative to a country’s own currency. Moreover, a dollar peg stabilizes exchange rates between trading partners and maintains competitive pricing for exports to the United States.
Notwithstanding, the dollar’s share of global reserves has dropped from 73 percent in 2001 to 58 percent in the last quarter of 2022. Its weaponization via the Clearing House Interbank Payment System (CHIPS) and SWIFT raises concerns about manipulation. For instance, Iran’s banks have been banned from using SWIFT since the U.S. withdrawal from the Iran nuclear deal in 2018, but the country has increasingly adopted the RMB for transactions.
Dollar dependence also limits MENA countries’ economic sovereignty by increasing their vulnerability to fluctuations in the U.S. economy. For countries in debt distress, U.S. interest rate hikes and a stronger dollar resulted in higher borrowing costs, more expensive debt payments, and import price inflation, constraining their ability to counterbalance sluggish economic growth. As of 2021, external debt to private creditors—often denominated in U.S. dollars—increased to 42 percent in the Arab region.
Meanwhile, Gulf states’ economic focus is shifting towards the East. It is estimated that GCC countries’ trade with emerging Asia—including China—will surpass trade with the West by 2026.
The RMB’s increasing appeal
The RMB’s increasing appeal is notable across all three functions of money in the MENA region. Regarding the unit of account in international trade, Iraq’s central bank will employ the RMB to conduct trade with China, compensating for its domestic shortage of dollars. As a medium of exchange, the RMB was promoted in a $6.93 billion currency swap arrangement between the Chinese and Saudi central banks in November 2023. In terms of store of value in the reserve system, the RMB was also added to Israel’s $206 billion worth of foreign reserves to reduce its allocation for dollars and euros.
The RMB is relatively stable with an increasingly mature exchange rate formation. Unlike dollar-denominated loans, the RMB’s comparatively low-interest rates increased China’s demand for debt issuance. RMB interest rates recently reached rock bottom, displacing the Euro as the second-largest currency in global trade finance. With financing needs amounting to over one-third of its GDP, Egypt is exceptionally vulnerable to interest rate hikes and will experience high refinancing costs as its bonds mature next year. Egypt became the first country in the region to issue RMB-denominated bonds to reduce debt costs in October.
The Chinese Central Bank (PBOC) has catalyzed RMB internationalization through currency swap lines, RMB clearing banks, and the backing of an RMB cross-border interbank payment system (CIPS). These support RMB use in trade, finance, and emergency liquidity support. The UAE benefits from growing RMB usage as China’s top trading partner in the GCC, having recently extendeda $4.9 billion currency swap agreement with China. Meanwhile, the PBOC’s global swap line network delivered $170 billion in bailout financing by 2022, including to Egypt.
The MENA region’s importance under China’s Belt and Road Initiative (BRI) and the potential of RMB-denominated energy trade between China and GCC states are two emerging trade dynamics enhancing the appeal of the RMB. Gulf-China trade is almost reaching the combined trade of Gulf countries with the UK, the United States, and Western Europe. Indeed, the value of RMB-denominated transactions for countries in the BRI increased 90 percent year-on-year. The recent inclusion of Saudi Arabia, Iran, the UAE, and Egypt into BRICS+ has expanded the bloc’s access to new free trade areas, paving the way to broader de-dollarization coordination efforts.
Gulf states are receptive to energy trade in RMB. China’s significant energy demand and the Middle East’s status as a top oil exporter to China make oil trade in RMB a promising outlook. Saudi Arabia allegedly approved the investor status of its Public Investment Fund (PIF) in China, paving the way for the RMB-invoiced oil trade by permitting RMB reserves to be used for PIF investments. Trading in RMB also aligns well with Gulf countries’ economic diversification plans. China already completed its first RMB-denominated energy deal, importing around 65,000 tons of liquified natural gas from the UAE.
Uniquely, China is a world leader in developing its digital currency, enabling transactions to bypass the SWIFT system. The digital Renminbi has the same value as tangible RMB, offering faster, cost-effective interbank transfers, integration with international credit cards, and accessibility to foreigners. As a multiple-central bank digital currency platform linking major financial institutions from mainland China, Thailand, Hong Kong, and the UAE, Project mBridge builds on a Saudi-Emirati digital currency pilot project, succeeding in reducing intermediaries for faster interbank transfers in trade. By promoting local currencyuse, mBridge bolsters participating countries’ control over domestic economic policies and South-South trade. If successful for multiple-central bank digital currencies, mBridge could boost the BRICS+ momentum to develop a rivaling global financial system.
Roadblocks to de-dollarization
Stability, liquidity, and global acceptance are three preconditions for a currency to become a leader—all of which the RMB lacks. The dollar retains pre-eminence; a robust financial market props it up, and its share of foreign exchange transactions and debt issuance has not declined. China’s strict controls and shortcomings in capital account convertibility make it difficult for the RMB to become a liquid investment currency, registering a continuous decrease in the share of foreign investment in China’s onshore markets. Although improvements have been made to stabilize the RMB, there are limitations to China’s financial derivatives market for hedging against its volatility. Finally, building network externalities for a non-dollar alternative requires regionwide de-dollarization efforts in the Middle East. This is uncertain because of the costs of moving away from the dollar and MENA countries’ complex ties with the United States.
MENA countries have generally tied their economic interests to the dollar, and many of them pegged their currencies to the dollar. Also, the GCC’s dollar-denominated oil revenues have been rechannelled towards U.S. Treasury securities, stocks, and equities in the form of “petrodollar recycling,” further reinforcing the dollar’s centrality to the region.
As a global RMB financial infrastructure, China’s CIPS will hardly challenge Western-based systems. Compared to CIPS, U.S.-based CHIPS has around ten times as many participants and forty times as many transactions. Moreover, 80 percent of CIPS payments use SWIFT to communicate with international financial institutions.
Although China is becoming more involved in conflict mediation in the MENA region, its approach to regional security remains limited to diplomacy. In contrast, the United States has a security presence in the region that China may not yet want to—and arguably could not—assume. Notably, countries with military ties to the United States constitute almost three-quarters of foreign government holdings of safe U.S. assets, guaranteeing the dollar’s significant share of the region’s reserve currency.
For Gulf states, balancing the use of the dollar and the RMB will become a way of maintaining strategic neutrality amidst global geopolitical fragmentation. This approach to realpolitik entails pragmatic development and economic relationships. While the region will register the growing use of the RMB, this will hardly entail the subduing of the dollar.
