Dollar vs digital: Global currencies compete

The global financial system received a shock after the Ukraine war broke out and western sanctions froze Russia’s dollar reserves while seeking to exclude it from international transaction systems. The crucial messaging mechanism known as SWIFT was barred for Russia, creating hurdles for its major trading partners like China, as well as emerging economies like India. It was then that the idea of moving away from dollar transactions as well as creating an independent financial messaging system on the lines of SWIFT came up for discussion.

Little progress has been made on either front, but this was the genesis of the concept of de-dollarisation, which is viewed as a way to reduce the financial risks posed by increasing geopolitical tensions.

Moving towards an alternative currency could be seen as a logical next step, and the BRICS forum has been used as a sounding board for considering this possibility. The group, which comprises Brazil, Russia, India, China and South Africa along with new entrants Iran, Egypt, Ethiopia and the United Arab Emirates was presented with a proposal for a new currency at last year’s summit.

Mooted by Brazil, the suggestion was for the group to develop an alternative to the dollar as the world’s reserve currency. The problem is, and it is not a small one, that the creation of a new currency requires an enormous amount of complementarity between the countries involved in the process. A look at the euro, for instance, is illustrative. Even with the close trade and economic ties of countries within the European Union along with geographical contiguity, the development of a single currency has been a slow and difficult path.

In the case of the BRICS countries, there are even greater hurdles. This includes the vast physical distances between member countries as well as the equally wide ideological differences. The concept itself has highlighted fissures within the group. Russia and China are keen to explore the possibility, but India and South Africa have already declared they are not opting for de-dollarisation.

Against this backdrop, US president-elect Donald Trump’s recent irate comments on the prospect of the BRICS group creating an alternative to the mighty dollar, seem an excessive reaction. His threat of imposing 100% tariffs on the group could be viewed as hyperbole, except for the fact that he has had a history of implementing drastic policies in his previous tenure. Yet the reality is, despite his determination to levy punitive duties, these would be self-defeating, creating inflationary pressures in the American economy.

Trump’s fulminations are also unnecessary as the dollar retains its pre-eminent role in the global economy despite efforts to shift international transactions to other currencies.

There have been several contenders in the recent past for taking on the mantle of a second reserve currency, but none have had the heft to reach this goal. The euro, pound and the yen are considered the big four currencies, along with the dollar, but have yet to evolve as viable options to the greenback.

When the euro was launched at the turn of the century, it was forecast to be a powerful competitor to the dollar, but it faltered along the way. China has tried to position the yuan as a possible alternative, but it still accounts for only a minuscule share of worldwide foreign exchange reserves. 

This is despite the dollar having lost ground to some extent, with an increasing trend of diversification witnessed in global foreign exchange reserves. The International Monetary Fund has found the dollar has dipped in foreign exchange reserves of central banks and governments. It has fallen from roughly 70 per cent in 2000 to about 58 per cent currently. But the dollar continues to play a role in about 80 per cent of international financial transactions, retaining its role as the world’s reserve currency. 

India’s efforts 

As for India, it has been gradually trying to position the rupee as an international currency in a limited manner. For instance, it has revived the old rupee-rouble mechanism used during the era of the erstwhile Soviet Union to pay for large purchases of defence equipment. Now, a modernised version of the system is being utilised to deal with the mounting crude oil purchases from Russia. Currently, there is a huge imbalance in bilateral trade owing to large-scale oil imports. This ramp-up began after western sanctions on oil and gas sales in the wake of the Ukraine-Russia war. These prompted the latter country to offer oil at discounted rates, making it a leading crude oil supplier.

The downside to this development is that exports are minimal. Russia has responded recently, offering to make investments here in sectors like railway wagon manufacturing, oil refining and defence equipment. Rupee resources could be used to finance these investments.

India has also moved to trade in rupees with some countries in a bid to bypass the SWIFT messaging system. Several trading partners have already set up bank accounts for this purpose. Malaysia, for example, has agreed to settle trade in rupees. While these agreements are with selected countries, the argument is that some developing economies have a shortage of dollars and trading in rupees makes transactions easier for them. Clearly, however, there is an effort to reduce the risks of being entirely reliant on trade in dollars. 

What is of even more significance is the central bank’s launch of the digital rupee. In the long run, this innovative move will enable more efficient and cost-effective cross-border transactions. It could also turn out to be a more viable option than the new physical currency proposed by Brazil. In the future, such digital currencies could conceivably render physical ones obsolete, though there is a long way to go before reaching such a stage.

For the time being, therefore, de-dollarisation is likely to be a process that takes place in a marginal way, led by individual countries. Despite the anxiety of many countries to find a realistic alternative to the greenback as well as the messaging system that enables global financial transactions, the dollar looks set to continue being the world’s reserve currency for a long time to come. Any real challenge to the existing system is likely to come from technology and innovation, as it has in many other sectors. The rise of digital currencies could ultimately be the disruptors of traditional financial systems. Given the rapid pace of technological advancement in recent times, this scenario could occur sooner rather than later.

(Sushma Ramachandran is a senior journalist)