What if the dollar order falls?

The dollar’s global dominance is based on Saudis honouring their petro-dollar pact. But Saudis are now set to allow China to pay in yuan

India’s export performance this year will be very impressive. The manufactured goods exports will cross $400 billion, the highest ever. This is more than 40% higher than last year, and five times the growth rate of our GDP. It was made possible due to a focused approach by the Commerce Ministry, which had given targets product-wise and country-wise and tracked them closely. Even the various export promotion councils (EPCs) for textiles, apparel, engineering goods and chemicals were given targets. The government also launched the Production-Linked Incentive (PLI) scheme which has inbuilt export incentives. The major export products have been petrol and diesel, gems and jewelry, engineering goods and chemicals.

It must be kept in mind that to export $100 worth of refined petroleum, we import $90 worth of crude oil. Hence, just as exports have done well, so have imports gone up. Our imports of products like crude oil and mobile phones are close to $600 billion. The import of gold too crossed 1000 tonnes, which means an outflow of $70 billion of foreign exchange. The total trade deficit this fiscal year will probably reach $200 billion.

That represents the dollar shortage, i.e., the excess of imports over exports of goods and merchandise. Thankfully, the country earns dollars even from the exports of services, chiefly software, i.e., IT and IT-enabled services. In addition, there is tourism (which has gone down due to the pandemic) and consultancies. India is also the highest recipient of inbound remittances, which is about $80 billion. Hence, after counting dollar earnings from services, we have a smaller deficit. But still, there is a deficit of dollars. How does that gap get plugged? That gets done by capital inflows from investors who put dollars in the stock market, in private equity and in loans.

The international flow of dollars and balance of payments adjustment are okay in peacetime. But the Ukraine war has put a spanner in the works. Stiff sanctions, led by the United States, imposed on Russia means Russian exports cannot be paid for in dollars. That’s because the payment has to go through New York clearing, and the US refuses to honour any claim from Russian exporters. Even the overseas dollar wealth of Russian oligarchs and elites are being frozen and they are denied access. The US will surely put pressure on Swiss banks to freeze Russian wealth in that country. Suddenly, for the Russians, their big pile of $630 billion in foreign exchange is looking worthless. That stock of forex is stored in the form of US government-issued treasury bonds, or bonds from the European Union. These bonds can be encashed from those respective sovereign entities, or by trading. But if the sovereign nations who issued those bonds refuse to honour the claim, or repudiate the request for redemption, then those bonds become worthless.

Of course, Russia is not taking this lying down. Oil and gas are its major export earners. And the countries which import oil and gas from Russia, most notably countries like Germany, and even India, are not going to suddenly switch to other suppliers. So, the Russians are offering steep discounts in the price of oil to its customers.

India imports less than 1% of its crude oil requirement from Russia. But if it is getting oil at half the price, at a time when the oil price has crossed $100 per barrel and threatens to hurt the Indian economy, why not take advantage of the offer? Indeed, this is in India’s interest, and will help tame inflation and keep the trade and fiscal deficit in check. The Russians will be happy to see some of their oil being evacuated.

But India cannot pay Russia in dollars (though India too has a large pile of dollar-denominated foreign exchange) since the dollar payment has to have a leg in New York clearing, which the Americans will obstruct. So, India and Russia have worked out a Rupee-Ruble trade deal, where India pays for its oil imports in rupees to Russia, and the Russians in turn use those rupees to buy their Indian goods and imports. This will work perfectly if our imports and exports to Russia are evenly balanced. Unfortunately, they are imbalanced. So, we must find more goods to export to Russia, so that they can use the rupee payment which we make to buy more stuff from us. We have used a similar arrangement for trade with Iran, too, when it was under sanctions.

Saudi Arabia made a deal with the US during the Nixon era, that it would invoice its oil exports only in dollars. That has been the source of the global dominance of the dollar. During the mid-1970s, after the first oil shock, the earnings of Saudi Arabia and other Middle East oil producers were so very large and all in dollars that they were unable to absorb all the windfall gain. This was even after spending lavishly on arms and ammunition. So, those dollars got deposited in Wall Street and recycled as hefty loans to South America, which eventually led to the debt crisis there. This was the story of the petro-dollar and its dominance.

The first cracks are now visible in that dollar edifice. The Saudis have, for the first time, agreed to sell oil to China in exchange for Chinese currency (which will presumably be used to buy Chinese exports). This is similar to the India-Russia rupee-ruble trade. If this Saudi oil sale to China in yuan takes off, then other countries may ask for similar treatment. This will surely shake the ground beneath the dollar’s hegemony. We don’t quite have a global currency, nor is there yet a viable alternative to the US dollar. The world will collectively be worse off if we go back to a quasi-barter economy, by mutually exchanging each other’s currency. But given current trends, it looks like the dollar’s undisputed status as “king” of the trading and invoicing world is being challenged.

(The writer is a noted economist)
(Syndicate: The Billion Press)

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