FROM HEGEMONY TO RESERVE?

Rapidly changing geopolitical situation in the world puts enormous pressure on the global economy, turning upside down the old system of economic relations. Energy wars, trade wars, currency wars are as fierce as the conflict in Ukraine, leaving no doubt that global redistribution of the economy cannot be avoided.

One of its main components is the struggle for the position of the global currency, or rather the desire of the US to keep its dollar in that position on the one hand and Russia and China to introduce a powerful new currency or to teach the world to trade in their own currencies, on the other hand.

Hitting US dollar with Chinese yuan

Disconnection of major Russian banks from SWIFT, prohibition imposed by the West on its residents to conduct transactions with the Russian government institutions and Central Bank, provision of dollars and euros to Russia, and freezing of $300 billion of Russian foreign exchange reserves sent shockwaves through the foreign exchange markets. Apparently, Russia was clearly not prepared for such a large volume of sanctions. Although Russia, China and even Turkey have long attempted to switch to national currencies in mutual trade, they have not had time to take real steps in this direction. Sanctions took everyone by surprise. It is clear that the West, as the initiator of these sanctions, should have been prepared for their consequences. Yet a month after their introduction, it is clear that some details, like the ultimatum to sell Russian gas in roubles, came as a complete surprise to Europe.

There were other interesting developments in the world. A recent article in The Wall Street Journal claims that Saudi Arabia is moving closer to accepting Chinese yuan as a payment currency for its oil supplies to China. It is doing so in retaliation for what it sees as unfair policies of the US President Joe Biden. Saudis are unhappy that the US has withdrawn support against the Houthis in Yemen, lifted their terrorist status, and postponed planned arms sales to Riyadh.

It is possible that this information can be used to warn the White House, as details of potential new oil trade agreements between Saudi Arabia and China remain vague. Both sides have negotiated for years about pricing some oil sales in yuans, and that may not happen. Around 80% of global oil sales are priced in US dollars, the yuan is not freely convertible as a reserve currency should be, and Saudi Arabian currency, rial, is tied to the US dollar.

A life-saving straw?

There was another event these days called by the organisers of the economic dialogue ‘A New Stage of Monetary, Financial and Economic Cooperation between the Eurasian Economic Union and the People's Republic of China. Global Transformation: Challenges and Solutions’. During the dialogue, the participants decided to draft an independent international monetary and financial system between the EAEU and China. It is envisaged to be based on a new international currency, which will be set on the index of national currencies of member states and the prices of commodities traded at exchange stocks.

The EAEU is an economic union including Russia, Belarus, Armenia, Kazakhstan and Kyrgyzstan. The currencies of these countries have been hit the hardest in light of recent events, with excess demand (around 40-50%) for dollars and euros during March. To ensure financial stability, the Kazakh authorities since March 14 banned the export of foreign currency worth more than $10k, as well as gold bullions and investment coins.

Obviously, the crazy demand for the global reserve currency has eventually depreciated the national currencies of the EAEU member states. Particularly, following the collapse of the Russian rouble in mid-March 2022, Belarus rouble, Kazakh tenge, Kyrgyz som, Tajik somoni and Armenian dram fell by 45%, 16%, 15%, around 20%, respectively. Central banks of these states already borrow from their foreign currency reserves in order to somehow support the exchange rate and keep foreign trade statistics from falling into deficit.

It is clear that a long-term solution is needed. Therefore, switching to another currency (first ruble, then yuan) is seen as a life-saving straw. Moreover, First Deputy Chairman of the CIS Executive Committee Leonid Anfimov said that not only the EAEU countries, but the CIS also can use yuan as a reserve currency for mutual settlements instead of dollar and euro. He added that the era of the dollar was over; it will lose its position by 2025, and by 2030 there will be no dollar as a global reserve currency.

Is the hegemony of the US dollar as a reserve currency really coming to an end?

Dollar to lose positions

It is very likely that the US currency will lose its positions in the coming years. And it is not only about the sanctions against Russia. China, Russia, Turkey and other major non-Western economies have intended to get rid of the hegemony of the US dollar for years. There have been periodic attempts to switch to national currencies in mutual trade, to create some kind of new reserve currency, a new Bretton Woods III system. The Ukrainian crisis can only accelerate this process, as the sanctions against Russia may indeed raise fears in other countries about the possibility of similar actions against them in the future. Naturally, many central banks will seriously consider diversifying their currency reserves.

For example, the Governor of the Indian Central Bank, Shaktikanta Das, said that freezing of Russian foreign exchange reserves initiated by the US is a wake-up call for any country in the world. His opinion was published in Baijiahao. According to Mr. Das, many states may soon follow Russia’s example of reviewing the composition of their foreign exchange reserves.

According to a recent study published by the analysts of the International Monetary Fund (IMF), the US dollar's share in global reserve currencies has already declined steadily over the past 20 years as central banks have moved towards alternative currencies to diversify their assets.

"Central banks abandoned dollars in favour of two alternatives: one-quarter in yuans and three-quarters in currencies of smaller countries, which have traditionally played a limited role as reserve assets," Bloomberg reports citing the IMF’s study on the "hidden erosion of dollar dominance".

"Evolution of the international reserve system over the past twenty years has followed a gradual shift away from the dollar, as well as a recent, albeit modest, rise in the role of yuan and changes in market liquidity, relative profitability and reserve management. This makes non-traditional reserve currencies more attractive," said IMF experts and independent economists.

Meanwhile, in her interview with Foreign Policy, Gita Gopinath, IMF Deputy Managing Director, said: "If you ask me today whether the recent global events mean the imminent demise of the dollar, I would categorically say no. However, we are likely to see some countries rethinking how much of their reserves they hold in specific currencies."

Gopinath believes that greater use of other currencies in global trade will lead to further diversification of reserve assets in national central banks. "Countries tend to accumulate reserves in the currency in which they trade with other countries and in which they hold foreign market positions," says Gopinath. According to her, there is now a trend for other currencies to start playing a bigger role.

The share of the US currency in international reserves has fallen from 70% to 60% in the past two decades because of the strengthening role of other currencies, Gopinath notes. Beijing, for example, has been focused on internationalising yuan long before the crisis, but so far the Chinese currency has been unable to replace the dollar as a dominant reserve currency, with less than 3% of global bank reserves denominated in it. For this to happen, it needs "full convertibility of the currency, open capital markets and institutions that can support them. It's a slow process that takes time, and the dominance of the dollar will continue for some time," says Gopinath.

Trading in national currencies

In short, it is still very early to say ‘the king is dead, long live the king!’ Therefore, the most expedient move by central banks not directly involved in this whole mess would be to wait, observe and act as necessary.

Overall, the US dollar still accounts for around 50% of the global trade and around 59% as a reserve currency. Most of Azerbaijan's export-import transactions are conducted in dollars and euros, with dollar assets accounting for around 68% of the State Oil Fund of Azerbaijan (SOFAZ)'s investment portfolio, followed by assets in euros (20%) and British pounds (4.9%). The rest of the SOFAZ funds are in assets denominated in a number of other currencies, including the Russian ruble being just 0.7% of the overall portfolio.

About 90% of Azerbaijan's exports are energy resources, which are traditionally sold in the global market for dollars.

As for non-oil trade, Russia and Turkey are our main partners, and so far the transactions with these countries have been based on convertible currencies. Russian Ambassador to Azerbaijan Mikhail Bocharnikov recently told Azerbaijani media that there were difficulties with payment under contracts between the countries, which is due to changes in the exchange rate of the ruble. Switching to settlements in national currencies would help to solve this issue.

"In line with the Declaration on Allied Cooperation signed recently, we are planning to expand banking cooperation in national currencies, which will also help solve this problem. There are already positive steps in this direction," Bocharnikov said.

Azerbaijan has been holding similar talks with Turkey for years. But... there is no real result for either country yet.

Will recent global developments trigger the transition to national currencies in trade relations for Azerbaijan as well? It is quite likely. But how long it will take and what terms of transition will be offered questions to answer.