De-dollarisation of trade: Opportunities and challenges – Explained, pointwise

Introduction

The global dominance of the US dollar in international trade and finance has long been a topic of discussion among policymakers and economists. In recent years, there has been a growing trend towards “De-dollarisation of global trade”, where countries seek to reduce their dependence on the US dollar in international transactions. This shift is driven by a desire to reduce exposure to currency risk and increase economic autonomy. While there are opportunities associated with de-dollarisation, such as increased trade and financial independence, there are also significant challenges, including the potential for increased currency volatility and geopolitical tensions.  

What is the De-dollarisation of global trade?

De-dollarization of trade refers to the process of reducing dependence on the US dollar for international transactions, trade settlements, and financial operations. This can be achieved by using alternative currencies or assets, such as the Euro, Chinese Yuan, or even cryptocurrencies. The primary goal of de-dollarization is to diversify the global economy, minimize risks associated with the US dollar’s dominance, and reduce the impact of US monetary policy and political decisions on other countries.  

What is the need for the De-dollarisation of global trade?

The weaponization of trade: Countries need to reduce their reliance on the US dollar to protect their economies from sudden policy changes or geopolitical tensions that result from US monetary policies and sanctions. This necessity is evident in Russia’s push for de-dollarisation due to the impact of US sanctions on its economy.  

Monetary Sovereignty breach: There is a need for countries to establish greater control over their monetary policies and enhance their financial autonomy. This can be achieved through de-dollarisation, as demonstrated by China promoting the use of the yuan in international trade to increase its economic influence and independence.  

Global Financial Instability: The need for de-dollarisation arises from the desire to create a more diverse global reserve currency system, reducing the risks associated with overreliance on a single dominant currency like the US dollar. The European Union’s efforts to increase the international use of the euro are driven by this need for greater financial stability.  

Exposure to Currency Fluctuations: Dollarisation has increased countries’ exposure to currency fluctuations resulting from the US dollar’s volatility. For example, countries with high levels of dollar-denominated debt can be severely affected by fluctuations in the US dollar’s value, leading to increased debt servicing costs and financial instability.  

What are the global efforts towards the De-dollarisation of trade?

Aftermath of the 2022 Russia-Ukraine conflict: As the US and its allies imposed strict economic sanctions on Russia, including cutting off its access to the SWIFT payment system, Russia had to find alternative ways to conduct international trade and financial transactions. In response, Russia has been accelerating its de-dollarization efforts, increasing the use of alternative currencies like the Euro and Chinese Yuan for international trade, and developing its own payment systems like the System for Transfer of Financial Messages (SPFS) and the Mir payment card system.  

China’s Cross-Border Interbank Payment System (CIPS): Launched in 2015, CIPS is a payment system that facilitates cross-border transactions in the Chinese yuan.  

SDR-like basket currency for BRICS nations: BRICS nations (Brazil, Russia, India, China, and South Africa) have displayed increased cooperation and intent to change the dollar-dominated financial system.  

African Continental Free Trade Area (AfCFTA): AfCFTA, which started its operational phase in July 2019, aims to create a single market for goods and services across the African continent. One of the key objectives is to promote intra-African trade using local currencies, which can help reduce the reliance on the US dollar for trade settlements among African countries. 

European Central Bank’s TARGET2 System: Launched in 2007, the TARGET2 (Trans-European Automated Real-time Gross Settlement Express Transfer System) is a payment system for the real-time processing of cross-border transfers within the European Union. This system enables EU member countries to conduct trade and financial transactions in euros, reducing their reliance on the US dollar.  

How is India pursuing the de-dollarisation of trade?

Promoting Bilateral Trade Settlements in Indian Rupees: In this respect, the Reserve Bank of India (RBI) has permitted banks from 18 countries to open Special Vostro Rupee Accounts for settling payments in Indian rupees. This allows partner countries to bypass the US dollar and use Indian rupees for trade transactions, reducing reliance on the US currency and promoting the use of local currencies in international trade. Bangladesh has become the 19th country to settle bilateral trade with India using Indian rupees and Bangladeshi taka.  

Strengthening Trade Pacts with Partner Countries: India has been working on finalizing trade pacts with several partner countries, such as the UAE and Australia, to facilitate the use of Indian rupees in bilateral and global trade. By negotiating trade agreements with countries like the UK and the European Union, India is making efforts to establish the Indian rupee as a more prominent currency in international trade, furthering the de-dollarization process.  

Establishing Currency Swap Agreements: India has also been entering into currency swap agreements with different countries to facilitate trade and investment. For instance, the Reserve Bank of India (RBI) has signed an agreement to extend up to a USD 200 million currency swap facility to Maldives Monetary Authority (MMA) under the  SAARC Currency Swap Framework.

Expanding Local Currency Settlement Frameworks: India has been working towards expanding its local currency settlement frameworks with other countries to promote de-dollarization. In 2020, India and Japan expanded their Bilateral Swap Arrangement (BSA) to include local currency settlement, enabling trade settlements in Indian rupees and Japanese yen.  

Encouraging Regional Financial Integration: India has been actively participating in regional financial integration initiatives to promote the use of local currencies in trade. For example, India is a member of the South Asian Association for Regional Cooperation (SAARC) and has been working towards promoting the use of local currencies within the SAARC region.  

Promoting Cross-Border Digital Payments: India has been investing in cross-border digital payment systems to facilitate trade and financial transactions in local currencies. For instance, India and the United Arab Emirates (UAE) launched a Remittance Facility, which allows instant money transfers between the two countries in Indian rupees and UAE dirhams.  

Strengthening Economic Ties with Emerging Economies: India has been focusing on strengthening its economic ties with emerging economies like Brazil, Russia, China, and South Africa (BRICS) to diversify its trade partners and reduce its reliance on the US dollar. India, along with other BRICS countries, is exploring the possibility of creating a new development bank and a common currency for settling trade transactions among the member countries.  

What are the opportunities provided by the de-dollarisation of global trade?

Diversification of Risks: De-dollarization helps countries diversify their risks by reducing dependence on a single currency, the US dollar. By using alternative currencies, countries can better manage the impact of fluctuations in the dollar’s value and minimize the effects of US monetary policies on their economies. For instance, during the US-China trade war, China increased its use of the Yuan in international transactions to reduce the impact of tariffs and the dollar’s fluctuation on its economy. Increased  

Monetary Policy Autonomy: De-dollarization allows countries to exercise greater autonomy in their monetary policies, as they become less influenced by the US Federal Reserve’s decisions. For example, Russia’s efforts to de-dollarize its economy since 2014 have allowed it to maintain more control over its monetary policy, even amid economic sanctions imposed by the US and its allies.  

Strengthening Regional Currencies: De-dollarization can strengthen regional currencies by encouraging their use in international trade and finance, boosting their credibility and attractiveness to investors. Such as the promotion of the Chinese Yuan in the Belt and Road Initiative has led to its increased use in international trade and finance, raising its profile as a global currency.  

Encouraging Regional Cooperation: De-dollarization can foster greater regional cooperation among countries by promoting the use of regional currencies, leading to stronger trade ties and economic integration. For example, the BRICS nations (Brazil, Russia, India, China, and South Africa) have been exploring the possibility of using their national currencies for trade settlements and creating a new global reserve currency as an alternative to the US dollar.  

Reducing Sanctions’ Impact: De-dollarization can help countries insulate themselves from the effects of economic sanctions imposed by the US or other entities, by enabling them to conduct trade and financial transactions through alternative channels. For instance, Iran has been increasingly using barter arrangements, local currencies, and cryptocurrencies to bypass US sanctions and maintain its international trade.  

What are the challenges associated with the de-dollarisation of global trade?

Currency volatility: De-dollarisation can lead to increased currency volatility as countries transition to using new currencies for trade. This can create uncertainty for businesses and investors.  

Limited acceptance of local currencies: Local currencies may not be widely accepted outside of their home countries, which can create difficulties for international trade. Lack of liquidity: Local currencies may have limited liquidity compared to the US dollar, which can create challenges for large transactions.  

Limited use in financial markets: Local currencies may not have the same level of use in global financial markets as the US dollar, which can limit their usefulness for international trade.  

Resistance from established players: Established players in the global financial system, such as the US and other Western powers, may resist de-dollarisation efforts, which can create geopolitical tensions.  

Implementation challenges: There may be challenges in implementing de-dollarisation, including developing new payment systems and addressing legal and regulatory barriers. 

Should India focus on the de-dollarisation of trade?

Yes, India should focus on the de-dollarisation of trade, this can be done through: 

Reducing Dependence on a Single Currency: De-dollarisation will reduce India’s dependence on the US dollar as a global reserve currency, which will help insulate the Indian economy from any potential negative impacts of global events. For instance, in recent years, India has faced difficulties due to the impact of global events like US sanctions on Iran and Russia, and the COVID-19 pandemic. De-dollarisation can help minimize the risks associated with these events.  

Promoting Regional Trade: De-dollarisation can promote regional trade and cooperation, particularly with BRICS nations, which will help India reduce its dependence on Western powers. For example, India has been exploring the idea of using the Indian rupee in bilateral trade with oil-exporting countries and has created a multi-agency task force to compile a list of countries where India could trade in rupees. This will promote regional trade and reduce dependence on the US dollar.  

However, de-dollarisation comes with challenges, including the need for infrastructure to support new payment systems and potential currency volatility. India will need to carefully navigate these challenges to successfully implement a de-dollarisation strategy. 

Sources:  Indian Express, The Times of India, Organiser, Indiatimes, Firstpost, The Hindu and ORF

Syllabus: GS 3: Indian Economy – Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.