Currency diversification

Emerging economies are exploring ways to diversify the international monetary system

With the recent decline of the US dollar in international reserves, transactions and pricing, the international status of the currencies of emerging economies has been gaining traction.

As a reserve currency, the International Monetary Fund's Currency Composition of Official Foreign Exchange Reserves (COFER) data shows that the share of the US dollar in international reserves reached a temporary high of 66 percent in 2015, and it has been slowly declining ever since, down to 59 percent as of this March. During the same period, the combined share of the four major currencies (US dollar, euro, yen and pound sterling) in global reserves has dropped from 93.7 percent to 89.1 percent.

In terms of the US dollar's role in international transactions, according to the Society for Worldwide Interbank Financial Telecommunication (SWIFT), from late 2015 to just before the outbreak of the Russia-Ukraine conflict in 2022, the share of the US dollar in international transactions fell from 43.9 percent to 40.5 percent, while the share of the euro grew from 29.4 percent to 36.7 percent.

The US dollar has also lost some of its appeal as a pricing currency. The Institute of International Finance has reported over 20 percent of growth in the total debt of emerging economies during the COVID-19 pandemic, many of which recorded the largest local currency bond issuance since 2003.Emerging economies have also stepped up the use of local currencies for commodity pricing and settlements, such as the use of the renminbi for cross-border settlements between China and Iran, Russia and India.

The current international monetary system is subject to the impact from various aspects.

Economically, the US dollar's share of international reserves and transactions falls during an economic downturn, but rebounded when the economy recovers. On the contrary, the international status of emerging economies' currencies rises when developed countries fall into crisis, but stagnated when advanced economies regained momentum.

Politically, after the outbreak of the Russia-Ukraine conflict, emerging economies had to rethink the problems within the existing international monetary system and turned to more diversified strategies for risk diversification.

Thanks to financial technology and digital currency, emerging currency and payment networks can quickly take shape, reducing the costs of breaking the externalities of traditional currency networks. Digital currencies and their payment networks may also make a foray into the areas that traditional currency networks cannot reach, creating certain conditions for emerging currencies to expand their network externalities.

As the international monetary system embraces diversification, the prospects can be foreseen over the next decade. If the global economic and political situation improves and digital technologies are globally adopted, the international monetary system will continue to evolve toward a diversified pattern characterized by one dominant currency alongside several strong contenders.

During this period of change in the international monetary system, it is essential for China to respond promptly in three key areas: economic, political and technological.

In the economic domain, the strategy of dual circulation should be continuously executed to advance the internationalization of the renminbi. Domestically, it must continue to strengthen the economic foundation, enhance its technological innovation capabilities, achieve high-quality economic development, as well as deepen and broaden its financial markets, so as to provide robust support for the internationalization of the renminbi.

Engaging with international players, China needs to expand its high-level openness, elevate China's systemic importance in the global value chain, and avoid decoupling from the world economy. At the same time, China needs to consolidate its role as a key importer and competitive exporter in international trade to increase the share of trade settled in the renminbi. Bulk commodity transactions priced in the renminbi should be promoted, international financial transactions denominated in the renminbi should be expanded, and the international financial infrastructure for renminbi transactions should be strengthened.

In the political sphere, China should strengthen communication and cooperation with both developed and emerging economies, to actively promote global financial governance. With the European Union placing more emphasis on global governance than the United States, the euro still has good promising prospects once the Russia-Ukraine conflict is calmed down. The future may see a tripolar international monetary system with the US dollar, the euro and the renminbi taking the lead.

China should enhance communication with the EU and other European countries, including the United Kingdom, to seek consensus and foster deep cooperation in global financial governance. China must also continue to enhance the voice of emerging economies in multilateral financial institutions such as the International Monetary Fund and the Bank for International Settlements. Together with other countries across the world, including the US, China should collectively promote international monetary system reform in a constructive manner, and create a fair, inclusive and effective global financial governance framework.

In the realm of technology, China should actively participate in and drive cross-border cooperation in digital currencies and the Web 3.0.China should engage in the global governance of digital currencies and cooperate with other countries to make the standard of central bank digital currencies.

It should also emphasize the complementary role of government agencies and market players in building the digital currency ecosystem. Recognizing the crucial role of market-driven networks in enhancing the network externalities of the digital renminbi, the government should encourage market institutions to leverage blockchain technology to issue stablecoins pegged to the renminbi.

The Chinese mainland may collaborate with the Hong Kong and Macao special administrative regions to construct the Web 3.0 system, creating a Guangdong-Hong Kong-Macao Greater Bay Area distributed cross-boundary payment platform, digital asset exchanges, a metaverse cross-boundary e-commerce platform, as well as corresponding regulatory technology systems.

Song Shuang is a research fellow with the international finance department at the Institute of World Economics and Politics, Chinese Academy of Social Sciences. Liu Dongmin is a senior research fellow and head of the department at the IWEP, CASS. The authors contributed this article to China Watch, a think tank powered by China Daily.

Contact the editor at editor@chinawatch.cn.