Janak Raj
The US dollar’s share in global foreign reserves peaked in 2001, and has been declining ever since. But while this trend is likely to continue, it is progressing very slowly, meaning that the greenback will retain its relative dominance—and the Global South will continue to suffer the consequences of US policy—for years to come. There is currently no easy alternative to the dollar. For a currency to attain reserve status, it generally must be freely convertible, with a market-determined exchange rate.
Moreover, the issuing country would typically possess a large economy, extensive international trade ties, deep and liquid financial markets, and stable macroeconomic conditions and policies. That reserve-issuing country should also be willing to run consistent fiscal and current-account deficits, in order to deliver sufficient liquidity, even as ever-expanding twin deficits risk undermining confidence in its economy (the so-called Triffin dilemma). On all these counts, the US still performs exceptionally well. But dependence on a dollar-based system carries significant risks for countries in the Global South. Highly exposed to shocks originating in the US, these countries often have to align their monetary policies with America’s in order to maintain currency stability and manage dollar-denominated debts.
Moreover, when the dollar appreciates, dollar-denominated imports, such as oil, become more expensive, driving up inflation and complicating macroeconomic management. If sanctions are imposed on the dollar-denominated international payment system, developing economies’ ability to engage in cross-border trade and finance is impeded. Finally, the US dollar’s dominance hampers the growth of deep and liquid capital markets for developing economies’ currencies internationally. Diversification away from the dollar is thus a strategic imperative for many countries. The question is how to go about it. Given that the dollar’s preeminence stems largely from its use in international transactions, one obvious action would be to promote the use of local currencies in international trade, such as through bilateral trade agreements.
Many developing and emerging economies are already doing this, especially when it comes to energy. India has begun rupee-based trade settlement with Iran, Russia, and the United Arab Emirates. China and Saudi Arabia are moving toward similar arrangements. Argentina and Brazil have begun to discuss establishing a common currency, which could go a long way toward advancing the shift away from the dollar, though it would have to be expanded to include all major trading partners in the Global South.
Central bank digital currencies are expected to bolster such efforts. The Reserve Bank of India has reportedly proposed putting CBDC interoperability on the agenda for this year’s BRICS summit. If successfully implemented, the interconnection of digital currencies, along with increased local-currency trade, could significantly reduce foreign-debt burdens, lower cross-border trade costs, and make imports more affordable.
Meanwhile, major emerging economies like Brazil, China, and India should work to expand their currencies’ share of international reserves. They have a long way to go: the Chinese renminbi currently constitutes less than 2% of global foreign-exchange reserves, and the Brazilian real and Indian rupee account for even less. But a few key steps—in particular, opening capital accounts further and developing deeper and more liquid financial markets—could go a long way toward accelerating progress. The inclusion of these currencies in global bond indices would also boost their international appeal and utility as reserve assets. A third step that developing countries should take to reduce their exposure to the US dollar is to increase their holdings of gold. Whereas reserve currencies are exposed to macroeconomic policy risks, inflationary pressures, and geopolitical instability, gold provides a reliable hedge against external inflation and currency devaluation, and carries no credit risk, making it a crucial “safe haven” during geopolitical crises. Though reserve currencies are more liquid and may earn interest, expanding gold holdings makes sense strategically. This process is already underway: since 2008, central banks, including in the Global South, have been consistent net buyers of gold. China has increased its gold holdings from 600 tons in 2008 to 2,306 tons last year, India from 358 to 880 tons, and Brazil from 34 to 172 tons. Nonetheless, as of last year, gold still constituted a small share of these countries’ reserves—7.2% in Brazil, 8.5% in China, and 16% in India. Bilateral currency-swap agreements are another good option.
Such arrangements act like a financial safety net, protecting against unexpected sudden stops and surges in capital outflows, and reducing a country’s need to accumulate massive foreign-exchange reserves. But very few developing economies currently have them. Finally, countries in the Global South should work to develop regional payment systems, which would enable them to bypass dollar channels and the SWIFT system for cross-border transactions. This is another area where efforts are already underway, with China’s CIPS (Cross-border Interbank Payment System) as one example. While the US dollar will not retain its preeminent status forever, countries in the Global South cannot afford to wait out its dominance. With a strategic approach, they can reduce their dependence on the dollar, thereby mitigating the associated risks and fostering a more balanced and resilient global financial landscape.
The writer is a senior fellow at the Centre for Social and Economic Progress.
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