The writer is an
analyst and the
President of All
The unprecedented financial sanctions imposed on Russia after its attack on Ukraine threaten to gradually dilute the dominance of the US dollar and result in a more fragmented international monetary system. An unintended consequence of Western punitive sanctions could be strengthening a Russia-China de-dollarization partnership, Russia’s de-dollarization efforts mean that China can help Russia skirt sanctions by jointly building an alternative global financial system. Joining such a partnership may also appeal to other countries, which have expressed interest in jointly exploring with Russia and China an alternative to SWIFT that would allow them to trade with countries under U.S. sanctions. Russian forces are now capturing territory across Ukraine, shelling military targets, and creeping closer to capturing the capital, Kyiv. U.S. President Joe Biden has led the international community in slapping punitive sanctions on Russian elites and firms with the intention of crippling the Russian economy and forcing a change, but so far, these measures have failed to compel Russia to accept a cease-fire or to withdraw. The sweeping measures imposed by western countries following Russia’s attack, including restrictions on its central bank, could encourage the emergence of small currency blocs based on trade between separate groups of countries. The dollar would remain the major global currency even in that landscape but fragmentation at a reasonable level is certainly quite possible.
“The dollar’s share of international reserves had fallen from 70 per cent to 60 per cent, marking its lowest level in 25 years. In fact, the de-dollarization trend has already emerged in a number of countries and regions.”
Some countries currently do not have their own domestic financial messaging system, are renegotiating the currency in which they get paid for trade, and planned to link a service currently under development with Russia’s SPFS System for Transfer of Financial Messages, Russia’s equivalent of SWIFT, which could connect with China’s CIPS Cross-Border Interbank Payment System, the Chinese version of SWIFT. Once materialized, the linked systems would cover most parts of the world. The global coverage of this alternative system could appeal to countries that are either vulnerable to U.S. sanctions or discontent about the U.S. dollar’s dominance. China’s CIPS currently has three direct participants in Europe and none in the United States. To avoid the potential risks and pressure, relevant countries may also choose other currencies of payment to circumvent the traditional dollar. That has already been attempted with success. After the US imposed unilateral sanctions on Iran, European countries established what’s known as the INSTAX barter system to continue trade with Iran while dodging US sanctions.
Russia has sought for years to reduce its dependence on the dollar, a campaign that accelerated in earnest after the US imposed sanctions in retaliation to its annexation of Crimea in 2014. Despite those efforts, Russia still had roughly a fifth of its foreign reserves in dollar-denominated assets just before the attack, with a notable chunk held overseas in Germany, France, the UK and Japan. Those countries have now banded together to isolate Moscow from the global financial system. Other actors besides governments have an incentive to develop alternative mechanisms to bypass sanctions. Corporate entities want to hedge the risk as well. Russian companies that are not directly impacted by U.S. sanctions have also been actively seeking to develop alternative payment mechanisms as a hedge against the dominance of the U.S. dollar. Since 2018, Russian state-owned miner Alrosa PJSC, the world’s largest producer of rough diamonds in carat terms, has successfully tested ruble payment with foreign clients from China and India. Russia’s best hope is that its de-dollarization mechanisms developed with China and others could provide immunization against Western sanctions. However, in reality, the current strength of the rouble and its supposed gold peg represent nothing but the weakness of Russia’s economy and its fiscal management in the face of Western sanctions.
It must be understood that the rouble is not quite an inconvertible currency yet – Russia’s banks are not yet under a blanket ban – but almost all trading takes place on Russia’s MOEX exchange. Exporters are required to sell their foreign currency to the state. Russia’s currency controls also mean that the rouble-gold peg is no return to the gold standard. A gold standard means that one can freely exchange a paper currency for gold. Russia’s gold peg, inversely, was to force Russian gold producers and sellers to accept a fixed amount of paper money for their gold production. In effect, Russia’s foreign exchange reserves declined by $39bn in March even as its central bank was barred by sanctions from intervening directly in rouble markets. The Russian state has to fulfill this role as demand for the rouble from abroad remains negligible. The vast majority of Chinese-Russian trade is not on rouble terms, and even the minority that is carried out in roubles is typically linked to the dollar, meaning that there is little financialization of the rouble in Chinese banks. Russian firms, too, have a thin history of issuing yuan debt. This is why President Vladimir Putin has been trying to get European countries to pay for their natural gas imports in roubles. However, it is precisely who the transaction is with that matters – creating demand for the Russian rouble from Western firms would not only support the rouble’s continued convertibility by keeping a hole in the sanctions regime open, but would also shift the currency risk off of the Russian state somewhat. If the rouble becomes completely inconvertible, Russia could be forced into a dual-currency system with a convertible and non-convertible version, as seen in Cuba or China with its domestic and offshore yuan (CNY and CNH), respectively. For now, Russia can sustain with its rouble strength thanks to a strong current account surplus meaning it has hard currency to spend, even as it faces looming default and has seen most of its assets frozen.
The dollar’s share of international reserves had fallen from 70 per cent to 60 per cent, marking its lowest level in 25 years. In fact, the de-dollarization trend has already emerged in a number of countries and regions including Russia, China and other countries. About a quarter of the decline in the dollar’s share can be accounted for by greater use of the Chinese renminbi. But less than 3 per cent of global central bank reserves are denominated in Beijing’s currency, IMF data show. Beijing was also in the process of internationalizing the renminbi before the current crisis and was already ahead of other nations in adopting a central bank digital currency. The war would also spur the adoption of digital finance, from cryptocurrencies to stablecoins and central bank digital currencies. The greater use of other currencies in global trade would lead to the further diversification of the reserve assets held by national central banks. Countries tend to accumulate reserves in the currencies with which they trade with the rest of the world, and in which they borrow from the rest of the world, so you might see some slow-moving trends toward other currencies playing a bigger role in reserve assets. The dominance of the dollar — backed by strong and highly credible institutions, deep markets and the fact that it is freely convertible — was unlikely to be challenged in the medium term. But in the past few years, the trend toward the de-dollarization of economies in the world has become increasingly apparent. The main task is to reduce its dependence on the world’s main reserve currency – the US dollar. Indeed, more and more countries striving to switch to settlements in national currencies, and the already-emerging global de-dollarization push could further accelerate with countries increasingly adopting alternatives to the US dollar. Although Pakistan has not been an enthusiastic advocate for such a de-dollarization partnership but has been exploring a rupee-ruble trade arrangement with Russia. Pakistan must seriously think about diversifying its foreign exchange reserves, increasing investments in other currencies, and by switching to settlements in its own national and other international currencies between partner countries.