Ever since the concept of an international reserve currency was introduced in the 1800s, primarily for ease and uniformity of transactions across borders, emerging economies have suffered, especially when said currency is appreciated. First, it was gold, then it was the pound-sterling and ever since WWII, it has been the US dollar.
Most recently, in the aftermath of the Covid-19 pandemic and the Russian invasion of Ukraine, developing countries like Bangladesh, Pakistan and Sri Lanka had been clobbered by high import payments and rising cost of debt servicing putting pressure on their foreign reserves.
The problem with the dollar
A strong dollar can make debt-servicing and import payments more expensive for developing countries and can often render the domestic monetary and fiscal policies within these countries ineffective. Economists Barry Eichengreen, Ricardo Hausmann, and Ugo Panizza have dubbed this problem the "original sin".
But it's not only the developing countries. The dollar's position as the global reserve currency means that investors want to hold on to dollars, raising its demand, especially during periods of crisis. This means that no matter what happens it is unlikely for the US dollar to suffer from a shock.
This sense of security has allowed the US to undertake reckless geopolitical stances, often at the cost of its allies, let alone developing countries. For example, the US sanctions on Russia have not only have failed to prevent Russian progression, but have depreciated other major currencies, including those of its allies like euro and the pound, by at least 11% since the start of 2022, a World Bank report from August suggests.
The US dollar has reached a 20-year high, reaching parity with the euro, making imports cheaper in the United States. On the other hand, its European allies are facing higher import costs; waiting for a very expensive winter, threatened with energy scarcity.
So, it makes sense for European economies, let alone their geopolitical rivals Russia and China to look for a feasible, long-term alternative to the dollar. And thanks to China's highly diversified economy and relatively stable economic growth over the years, the renminbi is being trumpeted as that most feasible candidate long-term, despite the euro's much more dominant position.
Can the renminbi replace the greeneback? What about the euro?
To assess whether the yuan can indeed replace the dollar as the global reserve currency, it needs to be understood how it (the dollar) came to occupy this position in the first place.
"The US dollar became the reserve currency of the world because traders around the world consider it to be a reliable currency. The US has a highly diversified economy and its institutions, regardless of what many say, remain democratic. Despite being a fiat currency, the Federal Reserve has never tried to get out of trouble by excessively printing money," said Dr Zaidi Sattar, Chairman, Policy Research Institute.
Dr Saleh Uddin Ahmed, the former Governor of Bangladesh Bank agreed. "There are acceptability issues with other currencies such as the euro or the yuan that need to be addressed first for them to become viable alternatives," he said.
In discussing the alternatives, it would be naive to assume that any currency is going to replace the dollar as the predominant reserve currency anytime soon. Rather, the focus should be on diversifying the foreign reserves with more and more currencies such as the renminbi or yuan and the euro. For instance, India's largest concrete maker UltraTech Cement has decided to pay for 1,57,000 tonnes of Russian coal in renminbi.
Many governments, financial institutions and companies are trying to make the renminbi an alternative reserve currency, given that China's trade in goods has, albeit narrowly, surpassed that of the US. However, when US trade in services is included in the equation, China still lags behind, considerably.
Moreover, the issue with currencies like the renminbi or the Ruble is the sheer lack of transparency regarding the economic policy and the policymakers which drive the valuation of these currencies.
As Dr Zaidi Sattar said, "When it comes to the Ruble or the renminbi, you cannot rely on the transparency of Mr Putin or Mr Xi Jinping. Since the decision-making process in these countries is rather undemocratic, it is difficult for traders to rely on these currencies as reliable alternatives."
In the case of the euro, since its inception, the pan-European currency had to grapple with multiple disasters in Greece and most recently, Brexit. europe's heterogeneity in terms of economic power, rising unemployment and trade deficit in most countries within the eurozone and the European Central Bank's failure to harmonise its monetary policy for each country within the region, have left the euro arguably in a weaker position than the Ruble, let alone the Chinese yuan or the US dollar.
Regardless, it appears that many countries are indeed warming up to the idea of a multipolar reserve regime with the Chinese yuan as the primary alternative to the dollar. In July, Indonesia, Malaysia, Singapore, Chile and Hong Kong pledged to each contribute 15 billion yuan to the renminbi Liquidity Arrangement. Meanwhile, the Chinese yuan has already become a de facto reserve currency in Moscow and is the most demanded currency in its stock exchange, due to the US sanctions on Russia.
"The Asian Clearing Union (ACU) already settles intra-regional payments without relying on dollars or euros. Organisations like this can play a key role in reducing the dependence on dollars. Moreover, if China's plan to create regional trading blocs as the RCEP succeeds, that can also aid in its pursuit of becoming an alternate reserve currency," said Dr Saleh Uddin Ahmed.
"China has already helped launch the Asian Infrastructure Investment Bank (AIIB) as an alternative to the World Bank within the Asian region. If it can indeed tackle the influence of the World Bank and IMF within the region, it might be possible for the yuan to become competitive against the US dollar in the long run,' said Dr M M Akash, Chairman, Department of Economics, University of Dhaka.
One study by Barry Eichengreen and Camille Macaire found that replacing the dollar as the global reserve currency would neither be easy nor would it be quick. But they also concluded that yuan reserves are increasing across countries that have tighter relationships with China. They believe that the renminbi has the potential to become an alternative to the US dollar in a multipolar world and it might take a few decades for the yuan to gain parity with the greenback.
For that to happen several things need to be changed first. The People's Bank of China (PBOC) needs to allow free trade of the yuan and relax its peg to the USD. The PBOC and that extension, the Chinese Communist Party need to become more transparent regarding its intentions with the yuan. The financial markets in China need to be more transparent and the monetary policies taken by the PBOC should be stable and driven by macroeconomic principles.
Can developing countries replace their reserve dollar?
Not yet. Developing countries will indeed be crucial in China's plan to replace the US as a global economic superpower and the success of regional trade organisations like the RCEP will also determine whether China can formulate a sphere of influence in the Asia-Pacific region.
However, as of now, only a few developing countries like Brazil and India can play around with their reserve currency thanks to the size of their economy, diversity of the product baskets and the sheer volume of trade.
Countries like Bangladesh have large trade deficits with both China and India making it difficult to trade in rupee or yuan. For instance, Bangladesh only exports around $2 billion worth of products to India and imports around $15 billion. So, it is unlikely that India would allow any more than $2 billion to be traded in rupees. The same could be said for China.
As Dr Saleh Uddin Ahmed added, "Larger economies such as Russia, China and India can diversify their foreign reserves thanks to their large volumes of trade. But least developed countries like Bangladesh still have a long way to go to achieve this feat."
Moreover, the vast majority of exports from Bangladesh either go to the EU or the US, making it difficult to diversify its foreign reserves. Unless Bangladesh can sign some bilateral free trade agreements with its neighbouring countries or join a regional trading arrangement like the RCEP, it will have to rely on trade in USD or euro for the foreseeable future.
That being said, Bangladesh has begun reducing its reliance on the dollar as the greenback's share in Bangladesh Bank's foreign reserve fell from 81.5% in January 2017 to 75.2% in August 2022. Meanwhile, alternate currencies such as the euro and the yuan's share in the foreign reserve rose to 4.9% and 1.3% in August 2022 from 3.8% and 1%, respectively.