De-dollarization: BRICS nations mull local currencies for trade

What is de-dollarization? What would be its impact? Why is it gaining momentum in today’s geopolitical stage? Read here to learn more.

At the 16th BRICS summit in October 2024, BRICS countries discussed increasing the use of local currencies in trade or creating a new BRICS currency, to reduce reliance on the US dollar.

In response, US President-elect Donald Trump stated that BRICS nations could face 100% import tariffs if they support a currency to replace the US dollar as the global reserve currency.

This has intensified discussions on de-dollarization and the creation of a multipolar financial system.

De-Dollarization

De-dollarization refers to the process by which countries reduce their reliance on the US dollar in international trade, finance, and foreign exchange reserves.

This trend has gained traction as nations seek to diversify their economic dependencies, enhance financial sovereignty, and mitigate risks associated with dollar-centric global systems.

Key Indicators of De-Dollarization:

• Energy Transactions in Non-USD Currencies:
  • Increasingly, energy-exporting countries and major importers are settling transactions in currencies like the euro, yuan, or local currencies.
  • Examples include agreements between China and Russia for energy trade in yuan and rubles.
• Emerging Payment Systems:
  • New cross-border payment mechanisms bypassing U.S. banks and SWIFT (e.g., China’s CIPS and Russia’s SPFS) are gaining traction.
  • Regional payment initiatives, like India’s Rupee-based trade settlement mechanism, are also challenging USD dominance.
• Decline in FX Reserves Share:
  • The USD’s share of global foreign exchange reserves has decreased, especially in emerging markets, as countries diversify into other currencies like the euro, yen, and gold.
  • According to the IMF, the dollar’s share of reserves fell below 60% in recent years, down from over 70% in the late 20th century.

Why De-Dollarization is Gaining Momentum

• Geopolitical Shifts:
  • Increasing economic sanctions by the US have encouraged targeted countries like Russia, China, and Iran to explore alternatives to the dollar.
  • Efforts to counterbalance US economic dominance in global affairs.
• Economic Diversification:
  • Countries seek to reduce vulnerabilities to dollar fluctuations, which impact trade balances, debt repayments, and inflation.
  • Diversifying currency reserves to include the euro, yuan, and gold.
• Rise of Multilateral Institutions and Agreements:
  • Expansion of regional trade agreements that use local currencies.
  • Initiatives by blocs like BRICS (Brazil, Russia, India, China, South Africa) to create payment systems independent of the dollar.
• Technological Innovations:
  • The development of digital currencies and blockchain technology offers new avenues for global transactions without dollar intermediation.

Mechanisms of De-Dollarization

• Bilateral and Multilateral Trade in Local Currencies: Agreements between nations to settle trade in their domestic currencies (e.g., India-Russia trade in rupees and rubles).
• Use of Currency Swap Arrangements: Agreements to exchange local currencies at pre-determined rates for trade and investment, bypassing the dollar.
• Establishing Alternate Payment Systems: Russia’s SPFS (System for Transfer of Financial Messages) as an alternative to SWIFT.
  • China’s CIPS (Cross-Border Interbank Payment System) for yuan transactions.
• Accumulation of Alternative Reserve Assets: Central banks increase reserves in gold, euros, or other currencies.
• Promotion of Digital Currencies: Central Bank Digital Currencies (CBDCs) could facilitate cross-border trade without dollar reliance.

Examples of De-Dollarization in Action

• China:
  • Promoting the yuan through the Belt and Road Initiative (BRI).
  • Oil and gas deals with countries like Saudi Arabia and Russia settled in yuan.
• Russia:
  • Shifted a significant portion of trade and reserves away from the dollar post-2014 sanctions.
  • Energy exports to China and India are increasingly denominated in local currencies.
• BRICS Nations:
  • Discussions to create a common currency or expand the use of local currencies in intra-BRICS trade.
• European Union:
  • Efforts to strengthen the euro as an alternative reserve currency.
  • Use of INSTEX (Instrument in Support of Trade Exchanges) for trade with Iran.

Challenges to De-Dollarization

• Dollar’s Dominance: Over 88% of global forex trades involve the US dollar (BIS data).
  • It remains the preferred reserve currency for central banks (60% of global reserves).
• Lack of Viable Alternatives: Other currencies, such as the yuan or euro, face limited global acceptance and convertibility issues. Cryptocurrencies, while gaining attention, are far from being viable substitutes due to volatility and regulatory challenges.
• Network Effects: The dollar is deeply embedded in global trade, finance, and payments infrastructure, making transitions costly and slow.
• Market Liquidity: The US dollar benefits from deep and liquid markets, which competitors struggle to match.
• Political and Economic Stability: Countries like China and Russia face scepticism due to political systems and economic policies, limiting trust in their currencies.

Factors Supporting Dollar Dominance

Despite these shifts, several structural factors ensure the continued dominance of the USD:

• Global Trust and Stability: The U.S. economy remains one of the most stable and transparent, making the dollar a haven during economic uncertainties.
• Liquidity and Network Effects:
  • The dollar is highly liquid, with a deep and well-developed market for U.S. Treasuries and other dollar-denominated assets.
  • Its widespread use creates a reinforcing cycle, as participants prefer the most widely accepted currency.
• Petrodollar System: Many oil-exporting nations, including those in OPEC, continue to price and trade oil in USD.
• Global Trade and Investment:
  • The dollar remains the primary currency for invoicing and settling international trade.
  • It dominates international debt markets, with a significant share of global borrowing in USD.

Potential Impacts of De-Dollarization

Impacts on the United States: 

• Reduced Global Influence: The U.S. dollar has been a cornerstone of global financial systems, giving the U.S. outsized influence in global markets. De-dollarization would diminish this power. Reduced control over sanctions and monetary policy’s global spillover effects.
• Erosion of the “Exorbitant Privilege”: Being the primary reserve currency allows the U.S. to borrow at lower costs and run persistent trade deficits. Decreased demand for U.S. Treasury securities could lead to higher borrowing costs and a weaker dollar.

Impacts on Global Trade:

• Multi-Currency Systems:
  • The rise of other currencies (e.g., the Euro, Chinese Yuan, or emerging regional currencies) could fragment trade systems.
  • Increased currency risks, hedging requirements, and transaction costs may complicate global trade.
• Shifts in Trade Dynamics:
  • Countries might bypass the dollar in bilateral trade agreements, fostering regional trade blocs.
  • The dominance of the dollar in commodities like oil may weaken, leading to new pricing benchmarks.

Impacts on Developing Nations:

• Increased Autonomy:
  • Reduced dependency on the dollar may enhance control over monetary policies and exchange rates.
  • Potential to reduce exposure to U.S. interest rate fluctuations, which have historically caused capital outflows and financial instability in developing economies.
• New Challenges:
  • Transitioning to alternative currencies or systems may involve initial costs and institutional adjustments.
  • Developing countries could face pressure to align with dominant regional powers backing alternative currencies.

Impacts on Financial Stability:

• Market Volatility:
  • Rapid de-dollarization could lead to disruptions in foreign exchange markets, with sharp adjustments in currency values.
  • Global financial systems reliant on dollar liquidity might experience instability.
• Shift in Reserve Allocations:
  • Central banks may diversify their reserves into gold, SDRs (Special Drawing Rights), or other currencies, altering demand dynamics.
  • A decline in the dollar’s reserve share (currently around 58%) could impact global liquidity.
• Systemic Risks: Sudden changes in global payment systems and trade mechanisms may lead to economic misalignments and potential recessions.

Conclusion

De-dollarization is a gradual but significant trend reshaping global economic dynamics.

While the US dollar’s dominance remains strong, the growing push for diversification reflects a desire for a more balanced and multipolar financial system.

Success will depend on the emergence of credible alternatives and the willingness of nations to adopt them.

While de-dollarization is a growing trend, the process will likely take decades due to the entrenched position of the USD in global finance. For meaningful shifts, substantial geopolitical and economic changes would be required, such as:

• Strengthening of regional currencies and alliances.
• Enhanced liquidity and global acceptance of alternatives like the yuan or euro.
• Major disruptions to trust in the U.S. economy or political stability.

In the interim, the world is likely to witness a multipolar currency system where the dollar remains dominant but shares space with regional currencies and other global contenders.

Frequently Asked Questions (FAQs)

Q. What is de-dollarization?

Ans: In short, de-dollarization entails a significant reduction in the use of dollars in world trade and financial transactions, decreasing national, institutional and corporate demand for the greenback.

Q. What happens if de-dollarization happens?

Ans: This would incrementally diminish the role and importance of dollars while creating a multipolar financial world where the next tier of economies would have significantly more say in global affairs.

Q. What is the strongest currency in the world?

Ans: The Kuwaiti Dinar (KWD) reigns supreme as the strongest currency in the world, with a value of 1 KWD equal to 3.25 USD. It all comes down to oil. Kuwait has some of the largest oil reserves globally, generating massive revenue for the country.

Related articles:

• Dollarization of Economy
• Report on currency and finance 2023-24

-Article by Swathi Satish