What you need to know:
- The percentage of US dollar reserves held as a share of the global central banks has decreased in the past 20 years from 72 percent in 2001 to 60 percent.
- Shifts in capital flows and changes in asset prices could result in financial instability due to our substantial dollar-denominated debt.
At the Bretton Woods conference in 1994, held in New Hampshire, USA, the dollar was crowned the world's reserve currency, replacing the pound sterling. This shift came about due to the aftermath of World War II, which left the better part of Europe outspent from financing the rather regrettable war.
For over 75 years now, the dollar has been the preferred currency for almost all international transactions, and many countries have built up significant reserves to finance and support their trade and investment activities. The dollar has been a key factor in the determination of prices for commodities such as crude oil, coffee, gold, cotton, natural gas, and wheat. In light of recent developments on the international stage, is the prestigious status of the dollar under threat?
Based on data from futures contracts, oil, gold, and base metals are the most commonly traded commodities on the global market. A shift in the use of the dollar in trading these commodities is consequential for the worldwide economy. Of late, there has been a growing conversation about dedollarisation in the global economy. Dedollarisation refers to the shift away from the United States dollar as the global reserve currency. This article examines the implications of Dedollarisation for Uganda, particularly in view of its nascent oil and gas industry.
The petrodollar system is the global practice of trading crude oil in US dollars rather than any other currency. This system was established in the 1970s when a six-page agreement between US President Richard Nixon and Saudi Prince Fand Ibn Abdel Aziz was signed to denominate oil sales in US dollars. The US was the leading oil importer at the time, and Saudi Arabia was the leading oil exporter. This resulted in enormous demand for the US dollar as countries needed to hold dollars to purchase oil, thus giving the US a dominant role in international trade and finance.
Global phenomena, such as the increased activity of the BRICS (a coalition of the economic powers Brazil, Russia, India, China, and South Africa), are driving the Dedollarisation agenda. For instance, China and Brazil recently declared that they would start trading in their currencies (beginning March 28, 2023).
Furthermore, some countries have agreed to pay for most of their Russian oil purchases in non-dollar currencies, including the United Arab Emirates dirham and, more recently, the Russian rouble. History was written on March 28, when the first Chinese-Yuan-conducted transaction for liquified natural gas (LNG) happened between China National Offshore Oil Corporation (CNOOC) and Total Energies, involving 65,000 tonnes of LNG.
Another noteworthy development happened on March 29, when Saudi Arabia announced that it would join the Shanghai Cooperation Organisation (SCO) as a dialogue partner. The SCO is a China-led intergovernmental organisation that advocates for security, political, and economic development.
These recent developments, combined with shifts in global economic dynamics, raise questions about the future of the petrodollar system. Data from Bloomberg and the IMF indicate that the percentage of US dollar reserves held as a share of the global central banks has decreased in the past 20 years from 72 percent in 2001 to 60 percent.
Uganda stands to benefit from Dedollarisation in a variety of ways. For example, reduced dependence on the US dollar means we are less vulnerable to changes in US monetary policy, which increases our monetary autonomy and allows us to adapt our policy to reflect our domestic economic realities.
According to the World Bank, Uganda does most of its trade with the UAE, China, India, Kenya, Tanzania, and South Sudan. With China and India being members of the BRICS coalition, our dependence on the dollar in our trade transactions is bound to significantly decrease with time. This also presents opportunities for Uganda and her neighbours to trade in regional currencies, thus promoting economic integration and regional trade and investment. This will lead to a more resilient and interconnected regional economy. Uganda has had a series of commercial deals with her neighbours, one of the most significant being the EACOP deal with Tanzania.
Given the massive regional investments in the energy space, there is a heightened opportunity for regional collaboration. Tools such as currency swap agreements are bound to strengthen and stimulate regional economic development. Perhaps this will accelerate the East African Community currency discourse: a currency with the potential to compete favourably on the global scale.
Furthermore, diversifying our reserve currencies gives us a safeguard against currency volatility and thus arms us with greater financial stability and lowers the probability of economic meltdowns, such as those caused when the US raises interest rates, as has been happening in recent months.
Notwithstanding the above, the shift from the dollar system could present far-reaching challenges, especially if our policymakers and major market players do not tactfully handle the situation. Shifts in capital flows and changes in asset prices could result in financial instability due to our substantial dollar-denominated debt. Exchange rate fluctuations are bound to become more volatile, leading to increased uncertainty and, consequently, potential harm to the investment climate. We risk having heightened exchange rate volatility, which could impact trade, investment, and capital flows. The situation, therefore, calls for adequate risk management and well-structured policies to prevent such undesirable outcomes. To be ready for this imminent shift, we need to take deliberate and carefully thought-out measures to strengthen the domestic financial systems to prepare for this fast-approaching evolution.
In conclusion, the shift away from the US dollar in the global economy presents both opportunities and challenges for Uganda. While reducing dependence on the US dollar provides opportunities for monetary autonomy, currency stability, and regional integration, the risks of financial instability and exchange rate volatility must be carefully managed through prudent policies. It is therefore essential for Uganda to take a proactive stand in managing this evolution to capitalise on the opportunities while minimising the risks.
Margie Mubeezi is an Associate in Assurance.