Is BRICS Nations’ Efforts Toward De-Dollarization Materializing Anytime Soon?
Photo by Annie Spratt on Unsplash
Until recently, most central banks held currency reserves in U.S. treasuries (around 59% of global foreign exchange reserves were in U.S. dollars), making it the world's largest and most liquid bond market and the most favoured currency choice for international trade.
Factors contributing to the dollar dominance include:
- The stability of the king-sized U.S. economy
- The geopolitical privilege that the U.S. enforced in the world
- None of the countries globally has a market for its debt similar to the United States, aggregating to approximately $22.5 trillion.
However, the dollar dominance may be witnessing its weakening, the beginning marked by Saudi Arabia's finance minister, Mohammad Al Jardaan, announcing to stay open to trading in other currencies alongside the U.S. dollar - for the first time in nearly 50 years.
The BRICS nations' new currency (in the developmental phase) to rival U.S. dollar supremacy is emerging, as Russian President Vladimir Putin announced at the 2022 BRICS Summit in Beijing.
According to the IMF Currency Composition of Official Foreign Exchange Reserves (COFER), there has been a decline in U.S. dollar shares held by central banks, owing to the competition from other currencies used by central banks for international transactions. It has declared that the U.S. dollar's share of official F.X. reserves fell to a 20-year low of 58% in the final quarter of 2022 and 47% when adjusted for exchange rate changes. This share was previously recorded at 71%.
This signals that the BRICS countries are positioning themselves for a new international currency system, accumulating gold. BRICS nations are also shifting towards self-sufficiency and trading among themselves without relying on U.S. currency.
Additionally, seven of the 13 OPEC countries have joined or applied to become members of the BRICS group. These countries consider the BRICS bloc an alternative to global bodies dominated by the traditional Western powers. The membership may unlock benefits for these developing nations by facilitating financing their development faster and increasing trade and investment opportunities. Additionally, the grouping will facilitate the creation of mechanisms to trade commodities outside the reach of the G7 financial sector.
After OPEC states join, BRICS like MSP would increase public and private investments in critical minerals supply chains among its allies and can significantly affect the global energy (gas and oil) markets.
All the OPEC countries are connected in the BRI initiative, which is the largest infrastructure development project in the history of humanity, aiming to connect Asia and Africa, Europe and South America.
The expansion of BRICS by adding Saudi Arabia, the UAE, and Iran implies the world's three largest oil exporters, making up 42% of the global oil supply, joining hands. This, in turn, means higher per capita GDP and robust economic power for BRICS nations, consequently challenging the dollar's status in the international debt market.
BRI is designed to shape these countries' future Geopolitical and economic environment by introducing a fresh maritime framework to enhance regional trade and uphold the principle of unrestricted navigation for corridor countries. A heightened Chinese naval presence in international waters can bolster energy security, maritime safety, and anti-piracy initiatives and safeguard critical infrastructure. This includes the global Internet backbone, which broadly aligns with the Maritime Silk Road (M.S.) course. All these will further strengthen the Yuan. On the other hand, the existing order of the U.S. Navy, enjoying undisrupted hegemony in many waters since World War II, will cease. And this will further weaken the dollar's autonomy.
BRICS NATIONS ENVISION EXPANDING THE BLOC
The recent summit witnessed divisions re-emerging among the leaders over a potential expansion of the bloc's ambition, giving the "global South" more clout in world affairs. Once the expansion is agreed upon, various other nations (some 40) already queuing up to join the BRICS bloc can join it formally or informally. More countries joining BRICS would like to position this group as a counterweight to the group of 7 (G7) and other Western-led alignments.
To de-dollarize USD, the bloc's New Development Bank (NDB) is an alternative to much-criticized and already established multi-lateral lenders -Breton Woods institutions. The BRICS group will increase its members count by adding six new nations in the January 2024 summit. These nations want to join the de-dollarization mission to remould their international trade and finance structure to protect their interest against future sanctions from the United States and its allies. Also, these countries support Beijing's development of multi-lateral organizations that protect their economic interest.
Including new participants in BRICS signifies the infusion of additional economic resources that can be effectively harnessed alongside an augmented collective influence. Furthermore, the BRICS will move toward the alter-West rather than the anti-West. The grouping will result in more significant interaction among the Global South, bypassing the Western world and without the participation of Western countries.
These BRICS nations want to fight decoupling, supply chain disruption, and economic coercion.
CHALLENGES IN THE DE-DOLLARIZATION PATHWAY
Photo by JESHOOTS.COM on Unsplash
BRICS countries have different-sized economies and governments with divergent foreign policies and goals. Hence, it becomes complicated for the bloc to finalize any decision as its consensus decision-making model renders each member a de facto veto.
Also, Brazilian president Luiz Inacio Lula Da Silva does not support the bloc seeking to rival the U.S., G20 and the G7 nations' wealthy economies. It could be because Brazil dominates South America, with China and the United States as its top two trading partners. Washington does not welcome a reduction in the use of the U.S. dollar in South America.
The potential for devaluation or loss of trust in the new currency is also a big challenge. If the new currency is more stable and liquid than the dollar, it could lead to economic stability and hinder financial transactions.
For instance, gold and oil are priced and traded in dollars. Shifting away from the dollar could complicate international transactions and make it more difficult to trade these commodities with Western nations. This could also hamper foreign direct investment and capital flows.
Unique challenges will surface for the countries with significant debt in USD. Moving away from the dollar would make their debt more expensive. Their currency may lose value; exchange rates may fluctuate, leading to financial instability and making it more challenging to repay the debt.
As countries would be less reliant on the U.S. dollar, there would be a critical need to adjust the global reserve assets, leading to shifting capital flows and changes in asset prices. Policy coordination and risk management are necessary for such fluctuations to bring financial instability in countries with significant debt in dollar domination.
To achieve stability, liquidity, and acceptability like the U.S. dollar, the alternate reserve currency must have a back in a robust economy, highly liquid financial markets, and sound monetary and fiscal policy framework.
Even the U.S. economy would be facing the consequences of de-dollarization. A significant decline in the value and performance of U.S. financial assets, particularly equities, would be inevitable due to reduced confidence and potential divestment. Additionally, real yields may face upward pressure as investors diversify or reduce their international reserve allocations.
OPPORTUNITIES THAT BRICS NATIONS WILL AVAIL
Countries like China and Russia strive to diminish the influence of the U.S. currency, counterfeiting American hegemony and mitigating the U.S. sanctions on the trade war. BRICS membership gives foreign countries access to more extensive and established economies' policy and technical expertise.
A few countries in the Eurozone favour de-dollarization as that will promote international usage of the euro, further enhancing their global economic position and awarding them greater financial autonomy.
Asian nations benefit from BRICS by enhancing economic cooperation, gaining political influence, accessing financial support through the New Development Bank, sharing technology and knowledge, diversifying alliances, and expanding global trade opportunities. This membership boosts their positions on the worldwide stage.
The added advantage of de-dollarization would be a more diversified and resilient global financial system, less vulnerability to a single dominant reserve currency, reduced risk of dependency on the U.S. dollar, minimizing economic stagnation and promoting financial stability.
IS IT REALISTIC TO IMAGINE THE BRICS USING ONLY THEIR CURRENCY FOR TRADE?
Photo by Cytonn Photography on Unsplash
A BRICS-issued currency perspective for success is undoubtedly new but still relevant. If the unified currency is used for international trade, it would weaken dollar dominance. The bilateral agreements add the effort to denominate trade in non-dollar currencies like the Yuan. Hence, it is realistic to imagine the BRICS nations using only their reserve currency to fund their imports built by themselves.
In 2022, owing to China, the BRICS group ran into a trade surplus, a balance of payment surplus of $387 billion.
With the help of the BRICS currency union, countries not sharing territorial borders can trade a wide range of goods compared to existing monetary partnerships and would become more self-sufficient.
Also, foreign investors will find assets denominated in the non-dollar currency unusually attractive. BRICS nations have reportedly planned to back their new currency with gold and other metals, having very high value resembling interest-paying gold.
CONCLUSION
The ascendance of BRICS can significantly influence Asian currency's value, roping in enhanced trade and economic collaboration in global trade transactions. Investments and financial activities can affect Asian currency exchange rates and stability. The collective economic clout of BRICS can influence exchange rates, thereby affecting the competitiveness of Asian exports. These effects, however, hinge on complex financial and geopolitical variables.
Although the concept of BRICS currency seems promising, some significant drawbacks characterize it. It will be primarily used for international trade rather than domestic circulation within any nation, further complicating the task of national central bankers in the BRICS countries.
It is also suggested that breaking the dollarization would make the global monetary order more multipolar than unipolar.
Although the de- dollarization is making its way, it will not happen anytime soon. The U.S. and E.U. have been the centres of attraction for investment into their bond market as these are stable economies and considered a haven for investment. For BRICS nations, it would be about reforming the capital market and fiscal reforms, not just the currency.
As China has the most significant share of BRICS GDP, the new currency probably would not make for a well-diversified currency and might result in Chinese currency having a prominent role in global trade. Hence, the challenges outweigh the opportunities, and dethroning the dollar anytime soon seems like a distant dream. However, the wheels to acquiring it have been set into motion already.
Join us at the Fixed Income & FX Leaders Summit APAC as we delve deeper into this topic:
Session: Day 2, 1PM: “Fireside chat: How is the depreciation of the U.S. dollar impacting G10 and E.M. currencies and which currency pairs should you factor into your portfolio to generate greater alpha?