U.S. media observations and thoughts: Will China squeeze the dollar out of the Middle East?
For the Gulf states, balancing the use of the dollar and the renminbi will be a way to maintain strategic neutrality amid global geopolitical fragmentation.
Article by Kristi Wing, The National Interest, March 22, 2024.
As China's geoeconomic influence continues to expand in the Middle East and North Africa, countries in the region are acutely aware of the risks posed by their dependence on the US dollar. The Middle East and North Africa region is on the rise in de-dollarization, from pioneering yuan-denominated energy deals to the recent accession of four Middle Eastern countries to BRICS+, which advocated for greater use of local currencies. However, the renminbi will not be a reliable alternative currency in the short term. On the contrary, the renminbi is one of the financial instruments used by Middle Eastern and North African countries to safeguard their long-term economic interests.
China's progress in trade, investment, and digital has certainly encouraged the adoption of the renminbi, but the dollar still plays an important international role as a currency with three functions: a unit of account, a medium of exchange, and a store of value. The U.S. dollar accounts for nearly 90% of foreign exchange transactions, half of global trade invoice currencies, and half of all cross-border loans and international debt securities. In addition, the US dollar has several advantages. It is a widely accepted medium of exchange that reduces international transaction costs. When the U.S. dollar is adopted in an unstable economic and financial environment, it also provides greater monetary stability relative to a country's own currency. In addition, pegging to the U.S. dollar can stabilize the exchange rate between trading partners and maintain the price competitiveness of exports to the United States.
Despite this, the dollar's share of global reserves has fallen from 73% in 2001 to 58% in the fourth quarter of 2022. The weaponization of the dollar through the Clearing House Interbank Payment System (CHIPS) and the Society for Worldwide Interbank Financial Telecommunication (SWIFT) has raised concerns about manipulation. For example, since the U.S. withdrew from the JCPOA in 2018, banks in Iran were banned from using SWIFT, and now the country is increasingly transacting in yuan.
Dependence on the U.S. dollar also limits the economic sovereignty of countries in the Middle East and North Africa, making them more vulnerable to fluctuations in the U.S. economy. For debt-distressed countries, rising U.S. interest rates and a stronger dollar have led to higher borrowing costs, higher debt-servicing costs, and higher import prices, limiting their ability to offset weak economic growth. As of 2021, the Arab region's external debt to private creditors, which is usually denominated in US dollars, has now increased to 42%.
At the same time, the economic center of gravity of the Gulf countries is shifting to the East. It is estimated that by 2026, the trade volume of the GCC countries with emerging Asian countries, including China, will exceed that with Western countries.
In the Middle East and North Africa region, the renminbi has significant appeal in all three of the three functions of the currency. In terms of the unit of account for international trade, Iraq's central bank will use the renminbi to trade with China to make up for its domestic dollar shortfall. As a medium of exchange, the renminbi was promoted in the US$6.93 billion currency swap arrangement reached between China and the Saudi central bank in November 2023. In terms of the reserve system's store of value, the renminbi is also included in Israel's $206 billion worth of foreign exchange reserves to reduce allocations to the dollar and euro.
The renminbi is relatively stable, and the exchange rate is becoming more and more mature. Unlike US dollar loans, the relatively low interest rate on the renminbi has increased the demand for bond issuance in China. Recently, interest rates on the renminbi have hit rock bottom, overtaking the euro as the second largest currency for global trade finance. Egypt's financing needs exceed one-third of its gross domestic product, making it highly vulnerable to higher interest rates, and refinancing costs will be high as its bonds mature next year. In October, Egypt became the first country in the region to issue renminbi bonds to reduce the cost of debt.
The People's Bank of China (PBOC) promotes the internationalization of the renminbi through currency swap lines, renminbi clearing banks, and support for the renminbi cross-border interbank payment system (CIPS). These measures support the use of the renminbi in trade, finance and emergency liquidity support. The UAE is China's largest trading partner in the GCC and recently renewed its $4.9 billion currency swap agreement with China. Meanwhile, the People's Bank of China's global swap network provided $170 billion in bailout financing by 2022, including financing to Egypt.
The importance of the Middle East and North Africa region in China's Belt and Road Initiative (BRI) and the potential for RMB-denominated energy trade between China and GCC countries are two emerging trade drivers that will enhance the attractiveness of the RMB. The Gulf region's trade with China is almost as large as the Gulf countries' trade with the United Kingdom, the United States and Western Europe combined. In fact, the value of transactions in renminbi in the BRICS countries increased by 90% year-on-year. Recently, Saudi Arabia, Iran, the United Arab Emirates, and Egypt joined BRICS+, expanding the bloc's access to new free trade areas and paving the way for broader coordinated efforts to de-dollarize.
The Gulf countries are receptive to renminbi energy trade. China's huge energy demand and the Middle East's status as China's largest oil exporter make the RMB oil trade promising. Saudi Arabia allegedly approved the investor status of its public investment fund in China, allowing the renminbi reserves to be used for public investment fund investments, thus paving the way for renminbi-denominated oil trade. RMB trade is also very much in line with the economic diversification plans of the Gulf countries. China has completed its first yuan-denominated energy deal, importing about 65,000 tonnes of LNG from the UAE.
Uniquely, China is at the forefront of the world in developing digital currencies, allowing transactions to bypass the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system. The digital yuan has the same value as the tangible yuan, providing faster and more cost-effective interbank transfers, integrating with international credit cards, and making it convenient for foreigners to use. As a multi-central bank digital currency platform connecting major financial institutions in Chinese mainland, Thailand, Hong Kong and the UAE, the mBridge project builds on the Saudi-UAE digital currency pilot project, which successfully reduces intermediaries and accelerates interbank transfers in trade. By promoting the use of local currencies, mBridge strengthens the control of participating countries over domestic economic policies and South-South trade. If the multi-central bank digital currency is successful, mBridge will push BRICS+ to build a global financial system that can rival it.
Obstacles to de-dollarization
Stability, liquidity, and global acceptance are the three prerequisites for a currency to become a leader, and the renminbi lacks them. The U.S. dollar remains dominant, with two strong financial markets supporting it, and its share in foreign exchange transactions and debt issuance not declining. China's strict controls and deficiencies in capital account convertibility have made it difficult for the renminbi to become a liquid investment currency, and the share of foreign capital in China's onshore market has continued to decline. While the stability of the renminbi has improved, China's financial derivatives market still has limitations in hedging against renminbi volatility. Finally, building cyber externalities for non-dollar alternatives requires region-wide de-dollarization efforts in the Middle East. This is uncertain due to the cost of breaking away from the dollar and the complex relationship of the Middle East and North African countries with the United States.
Countries in the Middle East and North Africa generally peg their economic interests to the U.S. dollar, and many of them have their currencies pegged to the U.S. dollar. In addition, the GCC's dollar-denominated oil revenues have also been diverted to U.S. Treasuries, equities and securities in the form of "petrodollar recycling", further reinforcing the dollar's centrality in the region.
As a global renminbi financial infrastructure, China's CIPS struggles to challenge Western systems. Compared to CIPS, CHIPS in the United States has about ten times the number of participants and forty times the trading volume. In addition, 80% of CIPS payments use SWIFT to communicate with international financial institutions.
While China is increasingly involved in conflict mediation in the Middle East and North Africa, its approach to regional security remains limited to diplomacy. By contrast, the U.S. security presence in the region may not be something that China does not want to afford, or arguably cannot afford. It is worth noting that countries with military ties to the United States account for almost three-quarters of safe American assets held by foreign governments, which guarantees a significant share of the dollar in the region's reserve currency.
For the Gulf states, balancing the use of the dollar and the yuan will become a way to maintain strategic neutrality in the midst of global geopolitical fragmentation. This approach to realpolitik requires pragmatic development and economic relations. While the region will increasingly use the yuan, this does not mean that the dollar will be suppressed.