De-dollarisation has been gaining credence for the past few months.
The US dollar's decades-old dominance as a reserve currency, medium of exchange or a unit of account has received a major challenge as more and more developing countries are calling for de-dollarisation. It calls for reducing the reliance on US dollar, which was given the coveted status by the Bretton Woods system established after the Second World War. Late last month, China and Brazil reached an agreement to settle trades in each other's currencies. And on Wednesday, Argentina said it will pay for Chinese imports in yuan instead of US dollars in order to preserve its dwindling foreign reserves.
All these steps are being taken to promote de-dollarisation. But what exactly is it? And why are the countries taking this path? Here's an explainer.
Is de-dollarisation a new concept?
The term could be new but countries have been calling for reducing reliance on US dollar for decades, with many heads of the states like Brazil President Luiz Inacio Lula da Silva criticising US hegemony in world trade.
China and Russia too are among the nations that have supported de-dollarisation. In January this year, it was reported that Iran and Russia will jointly issue a new cryptocurrency backed by gold, to serve as a payment method in foreign trade.
This is a latest step in creating a politically neutral reserve currency.
What gives the US dollar the power in international trade?
The dollar's pre-eminence has periodically been called into question and yet it has continued because of the overwhelming advantages of using the most widely-accepted currency for business. The US dollar began replacing pound sterling as international reserve currency in the 1920s since the country emerged from the First World War unscathed.
The Bretton Woods system cemented the dollar's position further after World War II. Since the US emerged stronger after the Second World War, the 1944 agreement established a post-war international monetary system that allowed the US dollar to become the world's primary reserve currency globally.
Why was the call for de-dollarisation renewed?
According to American Institute for Economic Research, the profound economic disruption experienced by Iran, and more recently Russia (for invading Ukraine), after being disconnected from the international dollar-trading systems like SWIFT, prompted smaller countries to look for alternatives.
India and Malaysia recently announced that they have started using the Indian Rupee to settle certain trades. Similarly, Saudi Arabia' finance minister told Bloomberg in January that the kingdom is open to discussions about trade in currencies other than the US dollar.
Last month, China too settled a test trade for natural gas with France in yuan.
What is a reserve currency?
This is the foreign currency held by central banks (in India's case, RBI) to facilitate international transactions, stabilise exchange rates and bolster financial confidence, according to Kumar Vivek, Deputy Commissioner at the Ministry of Finance, Government of India.
As per a US Congress report released in September last year, the US dollar is the world's dominant reserve currency, among others including the euro, the yen, the pound, the renminbi (RMB), the Canadian dollar, the Swiss franc and the Australian dollar.
It further said that central banks across the world hold about 60 per cent of their foreign exchange reserves in dollars, adding that about half of international trade is invoiced in dollars.
But having a single reserve currency has its own drawbacks. During the 2008 financial crisis, dollar's value whipped around unpredictably, and the more recent response to COVID (when the US Fed created dollars at an unprecedented rate to rescue the economy) created global imbalances and economic instability.
Also, currency with substantial exposure to dollar may face increased vulnerability to currency fluctuations, which puts these countries at a higher risk of financial crisis.
According to American Institute for Economic Research, the US dollar is the de facto currency of East Timor, Ecuador, El Salvador, the Federated States of Micronesia, the Marshall Islands, Palau, Panama and Zimbabwe. As many as 22 foreign central banks and currency boards have pegged their currency to it.
Is replacing US dollar with fiat currency of smaller economy a viable strategy?
As per American Institute of Economic Research, this strategy is not foolproof. Moving away from an established currency like dollar will impact a country's networking effect and create substantial barriers. US dollar is the cheapest means of access to acquire nominally risk-free US Treasury instruments.
A conference was held in New Delhi in March, which was focussed on increased cooperation between Brazil, Russia, India, China and South Africa. It discussed a possibility of launching a new currency as alternative to the dollar.
Though there is a renewed push to bring the importance of US dollar down, American Institute of Economic Research said that the fiat currency of the largest economy in the world will likely stay around for a long time in some shape or form.
