Sanctions Against Russia: A Threat to Dollar Supremacy?

 

The US and European countries imposed “earth-shattering” sanctions against Russia for its war against Ukraine, a war described by analysts as a “massive setback” for the global economy. As a result of the US sanctions, nearly half of the $ 640 bn gold and forex reserves of Russia were frozen. Additionally, Russian banks were disconnected from the Swift system thereby seriously curtailing their ability to transact with global banks. 

This weaponizing of the dollar by the US and its allies, it is feared, may fragment the global economy besides make it less efficient. For, it is not China—an increasingly close ally of Russia—alone that has so far scrupulously avoided criticizing the Russian invasion of Ukraine, but even countries such as South Africa, Mexico, Brazil, India, etc., have preferred to take a “balance approach”. Which is why it is observed that there is only Western-led coalition against the Russian invasion of Ukraine but not a global coalition. Yet, the US sanctions became highly significant for Russia, for it could no longer use its reserves denominated in dollars.

There is however a flipside to the sanctions: as the US dollar plays a dominant role in international trade, financial transactions, and Central Bank’s reserves—as of the third quarter of 2021, 59% of global foreign currency reserves were denominated in US dollars, 20% in euros, 6% in yen, and 5% in sterling—it is feared that such sanctions and the consequent freezing of Russian Central Bank’s reserves by the US and NATO countries is likely to fragment the global economy by sundering the global financial system into rival blocks.

Some analysts are of the opinion that freezing the Central Bank of Russia’s reserves are likely to “cause the US dollar to lose its credibility and undermine the dollar’s hegemony in the long run”. Indeed the speaker of Russian Duma, lower house of Parliament, Vyacheslav Volodin had already declared, “This is the beginning of the end of the dollar’s monopoly in the world”, for no country, according to him, can any longer be “sure that the US will not steal their money”.

Even according to the IMF, dollar’s dominance could be diluted due to the “fragmentation” of the system, as it is evident that some countries are already “renegotiating the currency in which they get paid for trade.” For instance, India, a country that is eager to maintain the independence of its foreign policy, is said to be evaluating the viability of the rupee-rouble arrangement that was in vogue in the early Soviet Union era, though no final decision has been taken yet. Some are even wondering if cryptocurrencies may chip in to circumvent the sanctions.

It is also feared that sanctions are likely to hasten the changes in the very payment infrastructure of international finance. In fact, as a part of its strategy to reduce dependence on US-controlled international payment systems, China has already developed its own renminbi-denominated Cross-Border Interbank Payment System (Cips). Of course, it is too small with an institutional membership of 1,200, compared to the European-based Swift system, but the fact of delinking Russian banks from the Swift might offer a potential growth opportunity to Cips. According to Eswar Prasad of Brookings Institution, Cips could one day provide an alternative to the Western-dominated international financial system, particularly Swift.

To put it in the right perspective, freezing the assets of the Central Bank of Russia is a “huge deal”, for it fundamentally, undermined the national credibility in the international monetary system. Yet, there appears to be no threat, at least immediately, for the dollar. For, there are no viable alternatives that can offer the level of liquidity and access that the US market offers for the countries that are holding huge international reserves. Even cryptocurrencies cannot be a threat to the dollar for their current market value is hardly $2 tn, a mere 16% of the global forex reserves. Secondly, transacting in cryptocurrencies is pretty cumbersome.

There are, of course, a section of analysts who believe that China with its formidable size of the economy may offer its renminbi as global money. But the harsh reality is that its financial system is relatively underdeveloped and its currency is not fully convertible, besides being not a big enough player yet in international finance. Secondly, it does not want to forgo its control over its domestic economy and society. It thus appears that there is no threat to the dollar’s “exorbitant privilege” that it enjoys as a global currency, at least in the near future.

There is yet another argument against this conclusion: The digital currency foray that China made—e-CNY—along with its Cips might emerge as an alternative payment mechanism, at least among its trading partners, besides even becoming a significant reserve currency. This may eventually lead to Western and Chinese-managed monetary systems operating differently, which is certainly not in the interest of an efficient global economy.