It appears the west has turned its back on Russia. Soon after the world’s largest country invaded Ukraine, in fear of the North Atlantic Treaty Organization (NATO) expanding eastwards, the west placed various sanctions to paralyze the economy of the country and weaken its leader, Vladimir Putin.
From the Olympics to the global payment network, SWIFT, Russia is banned from the international economic system, which connects it to the west. The measure led to the freezing of its USD 630 billion in foreign reserve, forcing a closure of its stock market and plunging the Russian Ruble’s value close to zero in the onset of the conflict.
The sanction has also left its citizens, from low-income earners to billionaires, in a predicament, as they become unable to access their funds from banks. Beyond the impacts of such measure on the international market, it is serving as a lesson for countries which are highly dependent on the US dollar, as the west weaponized the US-dominated global banking system, to penalize whom they consider an enemy.
This is leading to a faster de-dollarization of the world’s economy.
From Saudi Arabia, which has an agreement with the US to exclusively use the USD to trade oil in exchange for security assurance; to India, which has already started looking for other alternatives; countries are in a rush to reduce their overdependence on the US dollar.
This is a genuine concern considering the geopolitical risk that arises from using USD as a foreign currency reserve.
“Diversification away from the USD is meant to insulate economies from geopolitical risks,” said Sachchidanand Shukla, Chief Economist at Mahindra Group, in an opinion piece he wrote in the aftermath of the sanction that hit the Russian government.
Estimates indicate that over 60 percent forex reserves of central banks is held in USD, a currency that also accounts for 70 percent of the global trade, far from the meager three percent held in Chinese Yuan.
However, alarmed by the move to weaponize the US dollar to advance political interests, countries are shifting towards other currencies, including the Yuan.
With central banks looking to diversify their holdings in Chinese Yuan and other currencies, the USD is losing ground in the share of international foreign currency reserves.
A report by the International Monetary Fund on the USDs dominance in the global markets, and the share of reserve held in USD by central banks has dropped by 12 percentage points since the turn of the century, from 71 percent in 1999 to 59 percent in 2021.
One of the top officials at the IMF, Gita Gopinath, deputy managing director of the International Monetary Fund (IMF), warned the dominance of the US dollar is likely to fall in the world’s financial system, following a series of financial sanctions placed against Russia.
“The dollar would remain the major global currency even in that landscape, but fragmentation at a smaller level is certainly quite possible,” Gopinath said.
Following the sanction imposed on Russia, some countries have already started renegotiating the currency in which they get paid for trade. Saudi Arabia announced its decision to consider pricing its oil sales to China in Chinese renminbi (RMB) or the Yuan to reduce the influence of the dollar.
India is contemplating on trading using ruble and rupees to facilitate trade with Russia. China is also embracing digital currencies to de-dollarize its economy, a measure followed by the development of Central Bank Digital Currency (CBDC).
“China’s digital currency and other decentralized financial innovations threaten its position. The US has little choice but to compete by exploring its own CBDC and shaping a new governing framework, if it wants to maintain its leading role in the global financial order,” said Arjun Bisen, an economist.
Experts also suggest African countries embrace digital currency to de-dollarize their economies. Nantogmah Danaa, in a research conducted last year, concluded that digital currency technology provides Africa with a unique opportunity to develop and manage a single regional digital currency.
Last year, African Export-Import Bank (Afrexim), the largest pan-African financier, introduced a Pan-African Payment and Settlement System (PAPSS) to enable instant, cross-border payments in local currencies between African markets.
Its creators hope it would reduce the dependency on hard currencies during a trade between African countries, while it is expected to save the continent more than USD five billion in payment transaction costs each year.
According to Secretary-General of African Continental Free Trade Agreement, Wamkele Mene, implementation of the digital payment system is also beneficial towards placing Africa away from external control of financial systems.
Ethiopia is among those who are likely to benefit from the system.
“The System will enable a buyer in Ethiopia to pay for goods supplied in Ethiopian Birr and a Djiboutian seller to receive Djiboutian Francs, while the two respective central banks settle the net position of the trades between themselves,” said Amr Kamel, Afrexim bank‘s Executive Vice President in Charge of Business Development & Corporate Banking, during a three-day business roadshow in Djibouti.
While the rolling out of the System is a step in a right direction to facilitate trade, it is just a drop in the ocean in the quest to de-dollarize the economy of African countries.
As clearly outlined by scholars of the continent, de-dollarization requires restoring of macroeconomic stability and applying market-based incentives to encourage investors hold deposit in local currency, a measure that is yet to be realized by central banks of African countries.