Why Countries are Accelerating ‘De-Dollarization’?

Trading with local currencies is now a common practice in the world economy. Local Currency Trade (LCT) has gained so much traction that bilateral LCT agreements between countries are now widespread. Particularly in the wake of the pandemic and the crisis in Ukraine, several middle and small nations are now participating in LCT. Russia and Bangladesh recently announced intentions to repay payments in Yuan in order to get over challenges imposed by US sanctions against Russia. Prior to that, Bangladesh and India had inked an LCT agreement to conduct rupee-based trade. LCT is now preferred in many Eastern nations, not just Bangladesh, India, and Russia. Additionally, there are proposals about creating a new currency to replace dollar trading. In regard to this, it is important to look into the underlying reasons for the de-dollarization. And why the majority of countries in the global south wish to abandon the dollar—the dominant international currency.

De-Dollarization

The term “de-dollarization” refers to the process of shifting away from the use of the dollar in international trade. In order to lower risk and vulnerability in transactions, the dollar has traditionally been used for international trade. In addition, it is a result of US supremacy in terms of soft power and the world economy. De-dollarization is a strategy once used by nations to challenge the US. However, in the Post-Covid period, fluctuating foreign exchange reserves (forex) and the global dollar crisis are some of the main causes driving the current de-dollarization process. Geopolitical rivalry and dwindling confidence in the dollar, however, are also contributing factors at the moment to this process.

De-Dollarization Efforts

Local Currency Trade, or LCT, is a popular de-dollarization approach. LCT refers to cross-border local currency trade. Here, currencies are converted directly based on their exchange rates. The rupee-based trade agreement between Bangladesh and India is an example of LCT.

Aside from LCT, trade-in third currency is currently another aspect of the de-dollarization process. One instance is the repayment between Bangladesh and Russia in the Chinese Yuan. Bangladesh and Russia have decided to use Yuan to settle loans in order to evade US sanctions on Russia’s usage of the global gateway- Swift.

60 countries today are engaged in trading in their respective currencies. It is also being practiced by several of the US’s longtime allies in the global south, like India. India presently has LCT agreements with 19 countries. Saudi Arabia has begun to accept Yuan in the trade of oil. Other Gulf States are thinking about allowing yuan in the oil trade as well. Previously, oil was only sold by Gulf nations in US dollars. However, it appears that they are now thinking about taking additional currencies. Brazil and China have lately announced plans to trade in Yuan.

The idea of creating a new currency is another noteworthy initiative in the ongoing de-dollarization process. To facilitate trade among its members, BRICS has been working to launch a new currency. BRICS presently accounts for 41% of the global population and 31.5% of the global GDP. To decrease its reliance on the dollar, Indonesia is adopting the BRICS model.

Additionally, a new single currency known as the “sur” has been preliminarily adopted in Latin America. Brazil and Argentina, two Latin American giants, want to begin using the currency in their bilateral trade to reduce their dependency on the dollar.

Why Countries are Moving Away from Dollar?

The existing process didn’t happen over the course of a day or a year. Instead, it was a long-term process that lasted the past 20 years. The percentage of global reserves held in dollars is gradually decreasing. According to Bloomberg, the percentage of dollars held in foreign exchange reserves has decreased from 73% in 2001 to 58% by 2023. According to a further breakdown, the representation has decreased by 11% since 2016. And of this, 11%, 8% took place only in one year- 2022.

While the dollar’s portion in global reserves is declining, the Yuan’s stake is gradually increasing and presently ranks fifth in the world with a share of 3%. Yuan has overtaken the Euro as Brazil’s second-largest foreign currency in its forex reserve, which is one of the main drivers behind their LCT deal. China’s portion of the global FX reserve is growing along with its international commerce and investment. Additionally, a lot of nations are beginning to believe in the Yuan as a reliable and trustworthy currency. As a result, many countries are picking the Yuan over the dollar because using the Yuan in international trade also helps the nation keep a balance in its foreign exchange reserves.

In addition, the US has been leveraging its financial system to subjugate its geopolitical adversaries, particularly in the conflicts with China and Russia. This ‘weaponization’ of the currency is eroding international trust. The geopolitical usage of the dollar, which is seen as a universal good, is making the Chinese and Russians nervous. Russia is already prohibited from using Swift, making it difficult for it to conduct business with other countries.

The US administration’s unilateral actions and choices regarding the dollar further exacerbate the current dollar crisis on the global market. The US increased its interest rate eight times in the past year, which led to high exchange rates that affect people who use the dollar around the world. Political Scientist Fareed Zakaria also believes that the US itself is responsible for such a decline in dollar use because of its geopolitical use and weaponization.

However, in addition to geopolitical and trust issues, the de-dollarization process is also driven by high exchange rates and decreasing foreign exchange reserves in developing nations. Economy are already struggling in the post-Covid era and in the context of the crisis in Ukraine. They are turning to LCT to preserve their hard-earned dollars in order to prevent future distress. Additionally, these nations have grown to depend on both Russia and China in a complex manner. Therefore, they cannot simply disregard their commercial relations with these US competitors. They are using either LCT or yuan to keep these trade links going. For instance, Bangladesh pursues a foreign policy that is neutral and balanced toward the major nations. It must pay for a $12 billion nuclear project it has with Russia. So, Bangladesh and Russia are resorting to yuan to avoid sanctions-related complications. Same goes for Brazil, as it intends to utilize its reserve of yuan.

Even though the dollar’s share in global forex is declining, the ideas of launching new currencies are coming forward, trade in yuan is gradually increasing, and LCT are also increasing, Dollar still remains the single largest share holder in the market with 58%, with no eminent competitor. It’s closest competitor, Euro only has 20% share. Therefore, the current process can be termed as an ‘inception’. It is still to early to tell whether the process would end Bretton Wood system or not. Yet, there is no denying that Zakaria believes also, the US itself is to blame for the de-dollarization as it is failing to maintain trust, and has weaponized a public good.