The Dollar’s Hold and Emerging Alternatives

I facilitated a training session last week, during which I used India and Indonesia as two of the largest buyers of Nigeria’s crude oil in the latest figures released (Q2 2022) as an analogy to drive home a point. During the break, a participant approached me to ask why we have to pay India and Indonesia in dollars instead of the rupee and rupiah, respectively. In his mind, if South Korea is one of our top ten exporting countries, why are we paying them in dollars instead of won? No wonder we have to hold a lot of dollar reserves, he mused.

It’s a clever idea, but it’s a bit more complicated. It’s akin to all 36 states in Nigeria having their own currency, and you buying in LAG (Lagos’ currency) anything you purchase from Lagos, while the person in Abuja pays you in ABJ. The issue arises when you end up with a surplus of IMO (Imo’s currency) from someone buying your goods from Imo, but you have no use for that currency. You might possess a lot of KEB (Kebbi) and still have to dip into your limited LAG currency to pay for a service from Kebbi’s neighbor, Sokoto. To eliminate these unnecessary trade complications, the Naira is the best choice. Whether in Adamawa or Delta, the Naira is universally accepted for free use.

This mirrors the role that the dollar plays in global trade. The dollar serves as a universally accepted currency for international transactions.

However, this hasn’t deterred countries from attempting direct exchanges. Just last week, for the first time, India’s flagship refiner, Indian Oil Corp., purchased a million barrels of oil from the UAE, using Indian rupees as payment. Narendra Modi, the President of India, has been particularly vocal about using rupees to settle cross-border trades. The plan is that by using its local currency, India won’t need to maintain a large currency reserve in dollars, which it doesn’t have permission to print.

True, using the dollar helps countries simplify trade, but reliance on the dollar poses risks too. These risks include:

• Exchange rate risks, where having a strong local currency relative to the dollar makes imports challenging. Demand and supply come into play. The more a commodity is valued, the stronger it becomes. In 2015, the naira was 200 to the dollar. Now, it’s 900. Increased demand for the dollar is a result of poor economic management. China, in contrast, deliberately devalues its currency to make its exports attractive to other countries.
• Currency conversion costs, because using the dollar isn’t free of charge. Only the US is authorized to print the dollar. Converting currencies adds extra expenses due to fees and spreads charged by financial institutions.
• Enhancing the dollar’s prestige, at the expense of the local currency. This is self-explanatory; as more countries adopt the dollar, its prominence and recognition grow, overshadowing local currencies. Many countries believe this opportunity could be better utilized to elevate their own currencies.
• Risk of US sanctions, as seen with Russia. This particularly concerns countries like China and India, afraid that US sanctions could disrupt their economies. The US’s exclusion of Russia from its financial system has led to the Russian Ruble losing more than 25 percent of its value since the beginning of this year. China, in particular, is unwilling to take that chance and has been advocating for the use of the Yuan in international trade.

Yet, these risks are easier to write about than to act upon. Trade within countries is mostly conducted by traders from those individual countries, and most traders still prefer US dollars because most others do. Similar to how most people remain on Twitter (‘X’) because others do. A document released by the Bank for International Settlements in April shows that almost 90% of all global foreign exchange transactions are carried out in dollars.

The magnitude is so significant that even Russia isn’t enthusiastic about holding the currencies of smaller countries due to their easy disposability. Earlier this year, negotiations between Russia and India to settle trade in rupees fell through, partly because Russia didn’t want to hold rupees.

It’s a genuine Catch-22 situation, don’t you think? Joe Biden would be delighted.