De-dollarization

De-dollarization entails a significant reduction in the use of the U.S. dollar in world trade and financial transactions.

Globally, new payments systems are facilitating cross-border transactions without the involvement of U.S. banks, which could undermine the dollar’s clout.

USD’s share of FX reserves — the most commonly analyzed barometer of dollar dominance — has decreased, notably in emerging markets.

However, while diversification away from the dollar is a growing trend, the factors that support dollar dominance remain well-entrenched, and meaningful de-dollarization will likely take decades.

Reserve Bank of India (RBI) Governor Shaktikanta Das recently announced that India is not pursuing “de-dollarization”, and that recent measures promoting transactions in domestic currencies are intended to de-risk Indian trade.
The clarification came days after US President-elect Donald Trump threatened “100 per cent tariffs” against BRICS countries if they sought to reduce reliance on the US dollar in international trade.

Das said that BRICS (Brazil, Russia, India, China, South Africa) nations have discussed the possibility of a shared currency, but reached no decision. RBI decisions such as allowing Vostro accounts and entering local currency trade agreements are aimed at diversifying risk rather than reducing dependence on the dollar.

A key reason India is not backing de-dollarisation is the rise of the Chinese yuan as a challenger to the US dollar. India has resisted using the yuan for Russian oil imports, even as the acceptance of the currency is growing in Russia.
Following the Western sanctions on Russia, including freezing $300 billion in Russian foreign holdings, the yuan became Russia’s most traded currency last year.

At the same time, India is wary of over-dependence on the dollar. The RBI has increased gold purchases and has begun moving its gold, held abroad, back into the country.

Central banks, particularly in emerging market economies, have increased their gold holdings sharply so as to diversify away from a dollar-dominated financial system.

Depleting dollar reserves amid surging oil prices has recently caused considerable social and political unrest in India’s neighbourhood. Sri Lanka, Bangladesh, Nepal, and Pakistan witnessed sharp declines in their dollar reserves following the Ukraine war, which upset their trade relations with India. While India has managed to keep a robust reserve, the surging value of the dollar has become a concern.

To partially de-risk its trade ties, India is pushing for trade with Russia and the UAE in domestic currencies that could help cut reliance on the US dollar. However, the domestic currency trade has not yet picked up as expected because of India’s low foothold in goods and services trade internationally.
India’s efforts toward internationalising the rupee could get a boost if oil exporters begin accepting rupee payments. But they have remained hesitant due to the high transaction costs.

For the past 80 years, the US dollar has dominated as the global reserve currency. Dollar supremacy underpins the global financial system.

Today, the dollar is the most widely held reserve currency, playing a role in an estimated $6.6 trillion in daily transactions. Oil, despite efforts by OPEC+ and China to diversify pricing mechanisms, remains priced in dollars — just like most major commodities.

However, discussions about ‘de-dollarization’ have gained traction in recent decades. Driven by US sanctions and a growing shift toward multipolarity, countries such as China and Russia are increasingly using the Chinese renminbi (RMB) in trade. 

The BRICS bloc — including Brazil, Russia, India, China, South Africa, and new members like Iran, Egypt, and Saudi Arabia — is even exploring the creation of a new common currency to reduce dependence on the dollar.

According to the Center for Foreign Relations (CFR), a reserve currency is defined as “a foreign currency that a central bank or treasury holds as part of its country’s formal foreign exchange reserves.”
Countries hold reserves for a number of reasons including to withstand economic shocks, pay for imports, service debts and regulate the value of their own currencies. 

The US dollar, which is the world’s reserve currency, can see a steady fall in the current context as leading central banks may look to diversify their reserves away from it to other assets or currencies like the Euro, Renminbi or gold.

The “de-dollarization” by several central banks is imminent, driven by the desire to insulate them from geopolitical risks, where the status of the US dollar as a reserve currency can be used as an offensive weapon.

Thus, the war in Ukraine and the subsequent economic sanctions will trigger central banks to go back to their drawing boards to reassess their dependency on the greenback.

Efforts are already underway for the possible introduction of a new Russia-China payment system, bypassing SWIFT and combining the Russian SPFS (System for Transfer of Financial Messages) with the Chinese CIPS (Cross-Border Interbank Payment System).

The notion of de-dollarization sits well in the thought experiment of a multipolar world where each country will look to enjoy economic autonomy in the sphere of monetary policy.

Leading geopolitical adversaries of the US — Russia and China — have already started this process of de-dollarization. Other smaller powers are also joining the ranks. India has also had to work out alternative arrangements, including a barter arrangement, with certain sanctioned countries in the past.

Russia had started its three-pronged efforts towards de-dollarization in 2014 when sanctions were imposed on it for the annexation of Crimea.
First, Russia reduced its share of dollar-denominated assets to about 16 per cent in 2021. It had already announced that it would be cutting the USD from its $186 billion National Wealth Fund.

Second, it reduced its share of trade conducted in USD by prioritising national currencies in bilateral trade. The use of USD in Russia’s exports to BRICS crashed from about 95 per cent in 2013 to less than 10 per cent in 2020.
Third, Russia also developed a national electronic payments system called “Mir” in 2015 after several payment processing firms denied services to Russian banks.

However, these steps haven’t sufficed to effectively shield “fortress Russia”. China, on the other hand, aims to use trading platforms and its digital currency to promote de-dollarization.
China has established RMB trading centres in Hong Kong, Singapore and Europe. In 2021, the People’s Bank of China submitted a “Global Sovereign Digital Currency Governance” proposal at the Bank for International Settlements to influence global financial rules via its digital currency, the e-Yuan.

The IMF has already added Yuan to its SDR (Special Drawing Rights) basket in 2016. In 2017, the European Central Bank exchanged EUR 500 million worth of its forex reserves into Yuan-denominated securities. However, the lack of full RMB convertibility will hinder China’s de-dollarisation ambition.

Despite these efforts, the US dollar continues to reign, having sealed its position in the early 1970s with a deal with the oil-rich Kingdom of Saudi Arabia to conduct global energy trade in dollars.
The status of the dollar was enhanced by the collapse of the Bretton Woods system, which essentially eliminated other developed market currencies from competing with the USD.

This status of the reserve currency allows the US government to refinance its debt at low costs in addition to providing foreign policy leverage. Currently, about 60 per cent of foreign exchange reserves of central banks and about 70 per cent of global trade is conducted using USD.

The association of the USD as a “safe-haven” asset also has a psychological angle to it and like old habits, people continue to view the currency as a relatively risk-free asset. Given this psychological bias, the world will continue to prefer the USD as a “store of value” and a “medium of exchange”, fulfilling the basic functions of money.
Additionally, sudden dumping of dollar assets by adversarial central banks will also pose balance sheet risks to them as it will erode the value of their overall dollar-denominated holdings.

Thus, despite triggers to the move away from the dollar, in reality, it will be a protracted process. Apart from the Euro and gold, most other foreign currencies have some inherent risks associated with them. With the historically “neutral” Switzerland joining the EU in imposing sanctions on Russia, it eliminates the Swiss Franc from being an asset that can work as a hedge against economic sanctions.

Central banks are left with very few choices to diversify. Having said that, a drop in the dollar’s stature is inevitable as major economic powers like China and India rise.
The western hegemony of the financial system was challenged when the 2008 global financial crisis exposed underlying cracks within the US economy.

Moreover, demographic factors will continue to challenge Europe’s growth prospects. The rise of Asia as an economic powerhouse will raise the importance of currencies like the Yuan and the Indian rupee. But, while the frequent use of the US dollar as a potential weapon for achieving foreign policy objectives will no doubt accelerate the process of de-dollarization, there is still a long road ahead.