A significant event occurred last week. Its impact may not be felt immediately, but with time, it will be. Saudi Arabia did not renew the 50-year-old pact with the US on the petro-dollar.
History Of The Agreement
It was 1974, a year after the third Arab-Israel war when the Arabs had weaponised their oil resources and announced an oil embargo. To hedge against this weaponisation of the future's 'black gold', in June 1974, the US and Saudi Arabia set up a joint commission for economic cooperation. The commission was authorised to facilitate Saudi spending on US dollars. Both sides concluded a pact, whereby the pricing of crude became pegged to the US dollar. This strengthened the dollar, giving it heft and an edge over all other currencies in the world, something that still underpins the existing global economic order. The Saudis also committed to investing surplus funds into US bonds in exchange for military support.
While it is true that the pact did not mean that Saudis would sell oil in dollars alone, the emerging arrangement - the agreement to invest in US Treasury bonds - was a secret one, details of which emerged later. It translated into crude being not only priced but also sold exclusively in US dollars.
This year, the pact was not renewed. This has sparked off great jubilation, on one hand, about the dollar's imminent demise. On the other hand, some have dismissed it as being of no consequence. The truth, as usual, lies somewhere in between.
The Move Towards De-dollarisation
An unintended consequence of the US sanctions on Russia for its war in Ukraine, including cutting it off from the international SWIFT system, has been the beginning of a slow but sure process of de-dollarisation in the world. In order to hedge against such sanctions, a number of countries - mainly emerging economies - have begun using local currencies for bilateral trade. India, for instance, has been using the Indian rupee for trade with Russia. Last year, it made its first purchases of crude oil from the UAE in INR.
Madhu Nainan, the Editor of Petrowatch, however, warns that the probable beneficiary of the Saudi action could be the yuan, given the size of the Chinese economy. Over the last two years, China has emerged as not only the largest crude importer of the Saudis but also its largest trading partner.
Why The Yuan Can't Be Ignored
China is the largest buyer of crude oil in the world. Data for 2022 shows that Saudis exported crude to China worth $56.1 billion. India came in third, importing Saudi crude worth $32.7 billion. At the same time, the total trade turnover between China and Saudi Arabia was $106 billion. Of this, Chinese exports to the kingdom accounted for $36.5 billion. This is set to grow.
As the US-China rivalry increased, China has been pushing for the yuan for its external trade, including with Saudi Arabia. In 2023, China and Saudi Arabia signed a local currency swap agreement worth $7 billion as part of efforts to boost trade using their currencies and reduce their reliance on the dollar.
This year, Saudi Arabia signed on to the mBridge project, launched in 2021 between the central banks of China, Hong Kong, Thailand and the UAE to develop a new system for cross-border payments using central bank digital currencies.
The Iran-Saudi truce brokered by China last year further increased its footprint in the region, and Saudi Arabia, along with the UAE and four more countries, signalled its interest in joining the BRICS grouping of countries. The BRICS is in discussions for an alternate trading currency, with a number of member-states having initiated trade in local currency between themselves.
Hence, the Saudi decision, while not doing away with the substantial role of the US dollar, will definitely add to the de-dollarisation process underway in international trade.
An Opportunity For The Indian Rupee?
What does all this mean for India? India has ambitions of making the INR go international. It has already been trading with Russia in rupees. More recently, it entered into a local currency trade agreement with the UAE and has made its first oil purchases in INR. It is in discussions with Singapore for local currency settlement, which can then extend to the ASEAN bloc.
India is now also trying to diversify its foreign exchange reserves. Currently, as per Reserve Bank of India (RBI) data, India's overall exchange reserves stood at nearly $641 billion as of May 3, a large part of which is held in US Dollars.
At a recent event, RBI Governor Shaktikanta Das said, "Our priority is to diversify our deployment of forex reserves in more currencies and different types of assets, particularly gold." However, how the lapse of the petro-dollar deal will impact India remains to be seen. India's trade volumes with Saudi Arabia are nowhere near China's.
Data for 2023 reveals that bilateral trade between India and Saudi Arabia has grown and stood at a total turnover of $52.76 billion. During this period, India's imports from Saudi Arabia were $42.03 billion and exports $10.72 billion. With the balance of trade so heavily tilted towards Saudi Arabia, it is doubtful whether India can clinch a deal for paying for Saudi crude in INR.
Limited Possibilities, For Now
To put it in perspective, while India pays for Russian crude in INR, there is a growing problem with billions of rupees accumulating in Indian banks, with nothing for Russia to spend it on. If, however, India is able to accelerate its manufacturing base and increase exports, then a deal may be possible.
Neither will the demise of the petro-dollar deal impact the price of oil on the global market, as it will be pegged to supply and demand. Moreover, the Saudi rial remains pegged to the US dollar. Also, both the US and Saudis are reported to be negotiating a new security pack, whereby the central role of the dollar will again be reinforced.
At the same time, Saudi Arabia, like many other countries, is trying to diversify its foreign exchange reserves and reduce dependence on the US dollar. Thus, while the dollar will continue to hold sway in the foreseeable future, the world without a doubt is moving towards an alternative currency. The lapse of the petro-dollar deal will act as a catalyst for this de-dollarisation process.
(Aditi Bhaduri is a journalist and political analyst)
Disclaimer: These are the personal opinions of the author