Is US Dollar losing its edge as global reserve?

The US Dollar is at its lowest in IMF’s forex reserves. This reflects a growing mistrust in Washington’s policies, coinciding with the rise of non-reserve currencies

On July 3 it was reported that India is paying for Russian oil imports by Chinese Yuan (CNY)/Renminbi. Why should India be paying for Russian oil in Chinese Yuan? The transaction reflects the complex reality of the world economy. The last 15 years has seen a churn in world politics and economics which is reflecting in the currency markets.

USD dominance and rise of Euro

After World War II, the United States and the US Dollar (USD) dominated the world economy and world currency markets. The share of the US economy started to decline but the share of the USD in transactions and the USD as a reserve currency continued to remain high. Former French Minister Valéry Giscard d'Estaing coined the phrase ‘exorbitant privilege’ to explain the USD’s position. This privilege prompted select European countries to give up their currency for the Euro in 1999.

In 1999, the share of the USD in forex reserves was 71 per cent and the share of Euro was 17.9 per cent. Till 2008, the USD’s share declined and the Euro’s share increased steadily. In 2008, the US economy faced a major financial crisis which spilled over to the global financial markets. The crisis dented the image of both the US and the USD. Just as it was being felt that the Euro could replace the USD, the Eurozone faced a major crisis in 2010. In the next five-six years, the tables turned and the USD rose to 65 per cent, while the Euro declined to 19 per cent.

Pic Source: International Monetary Fund

Diversification and Rise of Chinese Renminbi

The 2008 Global Financial Crisis and the 2010 Euro crisis led countries to diversify reserve currencies. In 2012, the Australian and Canadian Dollars are included in the IMF’s database on forex reserves. The most important aspect of this diversification strategy is the inclusion of the Chinese Renminbi from 2016 onwards. As the share of the US’ economy in the world economy was descending, China’s share was ascending. However, the Renminbi could not make inroads in either transactions or in reserves.

Beijing chalked out a different plan for the internationalisation of the Renminbi. It started providing development loans to countries in South Asia and Africa in the Chinese currency. South Asian and African countries needed funds for both developmental purposes, and the loans from traditional sources such as the World Bank and the IMF came with preconditions of macroeconomic reform, which did not interest the leaders in these countries. The preconditions of Chinese loans were usually some strategic territory in the home country which was more acceptable to these leaders. These efforts and the dual US-Europe crisis gradually led the Renminbi to feature in IMF’s database on forex reserves.

From 2016-20, we again see decline of reserves in the USD and rise of the Euro along with diversification of the reserves.

Russia-Ukraine War

The Russia-Ukraine war has been a major disrupter, one of them being the view of the USD as a global currency.

Even if there was a decline in the USD based reserves, it remained dominant in international trade and finance. In 2020, IMF researchers showed that the USD was the dominant currency in pricing of international trade and finance.

After Russia’s invasion of Ukraine, the US and other Western countries imposed trade and financial sanctions on Moscow. While the sanctions were necessary to push Russia into ending the war, the swiftness with which they were implemented made everyone sit up and take notice. Apart from the USD dominance in trade and finance, the world banking system runs on SWIFT, which is again controlled by US-led developed countries. While every country always knew that it was part of an economic system driven by the USD, now many nations also realised that they could be cut off from this system at short notice.

Developing countries have faced additional pressure to maintain forex reserves in the USD for stability purposes. Given this geopolitical milieu, the need to build a non-USD based monetary system has never been more obvious.

India in the currency churn

In all this, the impact on India is limited to fluctuations in the global oil market. The Indian economy is majorly dependent on oil imports from abroad. If the events lead to a crisis or opportunities in the oil sector, India must act.

Since the Russia-Ukraine war began, India has seen a crisis and an opportunity. The crisis was that Russian oil was not reaching the market, thus spirally oil prices upwards. The opportunity was for India to buy Russian oil at a cheap price provided it could pay in any form other than the USD as there were sanctions. India first worked out payments by resurrecting the Rupee-Ruble payment gateway. Now is the news report about payments in the Renminbi. Russia-China ties improving means that Moscow can use Renminbi to trade with Beijing, and New Delhi is comfortable with both the Ruble and the Renminbi as it helps in being less reliant on the USD.

In the meantime, India has also chalked out another opportunity: Internationalising the Rupee. The government and the central bank are encouraging the usage of INR for international transactions. The RBI has released a report to further the strategy. It is likely that the INR will emerge as an international currency and reserve currency in future: the question is how much time it will take to be included in the IMF table.

(Amol Agrawal is an economist teaching at Ahmedabad University.)

Disclaimer: The views expressed here are the author's and do not necessarily reflect the views of DH