a year ago

Bypassing dollar in international trade

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Excitement runs high across the world to bypass or avoid the United States (US) dollar and use national currencies in international trade payments. Many developing nations have been trying to push their own currencies to settle trade with the partners for the last few years. Brazil, China, India, Indonesia, Malaysia and Russia are leading the move that has gained momentum since the breakout of Russia-Ukraine war. As the western nations led by the US have imposed a series of trade sanctions on Russia, it becomes difficult for the Russian partners to do trade with the country, rich in energy resources. The sanctions also cut off Russia from the SWIFT payments system which is the international network of bank transactions. So, it becomes impossible to settle any trade with Russia using the US dollar which is the universally accepted foreign currency as well as leading reserve currency. 

To get over the barrier, countries like China and India have already started using their local currencies to settle trade payments with Russia.  A few other countries have also joined the rally. Moreover, these countries now want to use the opportunity to ditch the imperious US dollar.

For many years, advanced developing countries have expressed their disappointments over the hegemony of dollar. They also alleged that dependency on the US currency has compelled the other countries to bear the cost of sudden exchange-rate fluctuation originating from the manoeuvring of the US monetary policy. For instance, when Federal Reserve, the central bank of the US, raises interest rate to fight inflation, it generally makes the dollar stronger. It is because the higher yields attract more investment capital from investors abroad who seek higher returns on bonds and interest-rate products. To invest in US bonds with higher returns, international investors offload their investments denominated in their local or regional currencies. Thus demand for dollar- denominated products increases and exchange rate becomes stronger in favour of the US dollar. A stronger dollar means weaker currencies for the other nations.

This may not always be the case. Developing nations most exposed to the changes in international financial market, face the situation since the central banks of these countries keep their interest rates unchanged. Interestingly, a standard textbook on economics says that high-interest currencies should depreciate.

Nevertheless, any small fluctuation in the US dollar price is bound to affect the rest of the world as countries are linked with the US-led global financial system. International trade is heavily dependent on dollar. According to International Monetary Fund (IMF) economists, the dollar's share, as an invoicing currency, is 3.1 times its share in global exports. The US currency's share as an invoicing currency is also estimated to be around 4.7 times its share in global imports. That means, many non-US exporters and importers invoice their international trade in the US dollar.  The share of euro is 1.2 times the share of euro-country exports.

The US dollar is also established as a `safe haven' as international investors use dollar for its effective currency hedge in times of turbulence that no other international reserve currency can provide. Although the share of US dollar as reserve currency dropped to around 59 per cent at the end of 2022 from 72 per cent in 2020, it is still the leading vehicle currency in global banking. Around 88 per cent of the foreign-exchange outstanding of all currencies at end-June 2022 is US dollar, according to Bank of International Studies Quarterly Review. Euro is the second reserve currency having a share of 20.50 per cent followed by Japanese Yen (5.50 per cent), British Pound Sterling (4.95 per cent), Chinese Yuan (2.70 per cent), Canadian dollar (2.40 per cent) and Australian dollar (2.0 per cent). The rest amount, some 3.40 per cent, is constituted of other currencies.

Thus, the Chinese currency is still far away to be a leading reserve currency no matter how some are arguing for its use as an alternative to the US dollar. Though the use of Yuan by some countries to settle their trade with China has increased in recent years and it will continue to grow in the near future, most countries are not ready to accept it as an important reserve currency.

In fact, the Chinese monetary policy is fundamentally less-transparent, if not non-transparent, and unpredictable which is not true in the case of the US. China also depreciates Yuan artificially as the currency is pegged. So, it makes the Yuan costly for other currencies.  China runs a huge trade surplus with the rest of the world.  Many argue that Chinese trade surplus is mostly 'shaped by residual and newly created forms of protectionism, undermining trade relations abroad and consumer welfare at home.' Chinese current-account surplus is also very big indicating its strong internal resilience not without any cost.

Although advanced developing countries are trying to reduce the use of US dollar in international trade, all of them are interested to push their own national currencies instead. It may create a kind of 'spaghetti bowl phenomenon' which is used to refer to the multiplication or crisscrossing of free-trade agreements (FTAs). In the race of using nation currencies, big developing nations may also create pressure on relatively small trading partners to use their own currencies to settle trade with multiple countries.

For instance, India now wants to use Rupee in exchange for Taka to settle trade with Bangladesh. As India has already started to trade in Rupee with some other countries, it may seek Bangladesh to use the Indian currency to settle international transactions with common trade partners like Nepal, Sri Lanka and Indonesia. Similarly, China may opt to do so. All this may make the foreign-exchange management difficult for countries like Bangladesh.

A regional common currency like Euro may be a better option where some countries agree to use the common currency in intra-regional trade. If the intra-regional trade payments see a success, the currency may be used for international trade transaction later. BRICS, the bloc of Brazil, Russia, India, China and South Africa, has already initiated move to introduce a common currency. Problem is that even the nations having more economic strength within the bloc or region may try to convert their national currency as the common currency which may not be acceptable to all the regional partners. Thus, the move to ditch the mighty US dollar will see little success in near-future. 

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