Geopolitical tension has intensified recently, accompanied by frequent use of economic and financial sanctions, mainly by the United States and its allies. Furthermore, there has been growing discontent in the rest of the world with the Fed’s conduct of monetary policy—believed to have caused wild swings in capital flows and exchange rates, especially of emerging market countries. Consequently, more and more countries have tried to develop alternative cross-border payment mechanisms to reduce their reliance on the US dollar (USD). Basically, pairs of countries have agreed to settle cross-border trade and investment transactions between themselves in their local currencies, facilitated by bilateral currency swap lines arranged by their central banks.
These bilateral cross-border arrangements do not constitute a threat to the premier position of the USD—as claimed by some over-enthusiastic proponents of those schemes—since no alternative currency has been put forward that is fully convertible and freely usable by anyone anywhere. Nevertheless, they are fragmenting the global payment landscape—which creates substantial costs in terms of lost economic efficiency and risks to financial stability as part of the larger geopolitically driven fragmentation of the global economy, according to the International Monetary Fund (IMF).
It remains to be seen if the perceived benefits to those choosing to use local currencies in cross-border payments—de-risking with respect to US sanctions and the USD—can offset the costs identified by the IMF. In the meantime, here’s a review of the bilateral cross-border payment landscape, from China to India to Russia and beyond.
The RMB in bilateral cross-border payments
China’s RMB has emerged as the most advanced currency used for bilateral cross-border payments. This has been facilitated by an extensive network of bilateral currency swap agreements the People’s Bank of China (PBOC) has signed with central banks of 41 countries, totaling 3.5 trillion yuan ($480 billion at current exchange rates). The balance of funds activated from those currency swap lines reached a record $15.6 billion at the end March 2023.
As a consequence, China has been able to use the RMB to settle about half of its cross-border trade and investment transactions—surpassing the now second-ranked USD. More generally, the IMF has found that for a sample of 125 economies, the median usage of RMB in cross-border payments with China increased from 0 percent in 2014 to 20 percent in 2021; for a quarter of that sample, the RMB usage has risen to 70 percent.
Going forward, two developments are worth watching. Firstly, the RMB has only been used bilaterally—between China and another country. Recently, however, the RMB has been allowed to be used to pay a third party—for example by India to pay for oil imports from Russia; and by Argentina to pay off some of its debt from the IMF. These isolated events could herald a possible multilateralization of the international use of the RMB—a development with important implications.
Secondly, the central banks of China, Hong Kong, Thailand, and the United Arab Emirates (UAE) have collaborated in the project called mBridge sponsored by the Bank for International Settlements (BIS), to develop a multi-Central Bank Digital Currency platform to facilitate interoperability and connectivity among them. This would make the digital RMB (eCNY)—and the digital currencies of other member countries—usable for cross-border payments in a multilateral setting. Again, this is an important project to monitor.
India promotes the rupee (INR) in cross-border payments
India has recently increased its efforts to promote the use of its currency—the INR—in cross-border payments. The latest example was the agreement signed on July 15, 2023 between India and the UAE to settle their trade in INR. In fact, India has had a long history of using the INR to settle trade with South Asian countries (members of the South Asian Association for Regional Cooperation—SAARC). In 2012, the SAARC Currency Swap Facility was launched for all eight members. An Asian Clearing Union including Iran and Myanmar is scheduled to be announced soon and will facilitate INR settlements.
More generally, India has allowed banks from 22 countries to open so-called Special Vostro Rupee Accounts (SVRCs) with banks in India to carry out receipt and payment transactions vis-à-vis Indian entities for their business and individual clients in their home countries.
Since India’s share of world trade is quite small—only 1.8 percent compared to China’s 15 percent—the usage of the INR in cross-border payments will likely be less extensive than that of the RMB.
Russia forced by sanctions to use the RMB
After its invasion of Ukraine on February 24, 2022, Russia has been put under comprehensive sanctions by the United States, Europe, and other allied countries. That included the freezing of the Bank of Russia’s foreign reserves kept in Western jurisdictions and the exclusion of many Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT). As a result, Russia has found it more difficult to settle international transactions in the USD or other major currencies (like the euro, British pound or the yen); and has to settle up to two-thirds of its trade and investment activities with China in RMB and rubles, according to President Vladimir Putin.
However, Russia and India have suspended efforts to settle trade in rupees and rubles, after months of negotiations. Instead, Russia has agreed to accept RMB as well as UAE dirhams from India in payments for some of its oil.
Putin signed a decree in March 2022 requiring “unfriendly” countries to pay for Russian gas in rubles. According to TASS, 54 foreign companies have opened so-called special K accounts with Gazprombank (which has not been excluded from SWIFT) to convert payments in a major currency into rubles before settling with a Russian gas exporter. If still in operation, this requirement aims to generate demand for rubles vis-à-vis major currencies and does not promote the use of rubles in cross-border payments bypassing the USD.
ASEAN local currency cross-border payments in a multilateral setting
The ASEAN Summit in May 2023 in Indonesia agreed to promote regional connectivity and local currency transactions (LCT). A Local Currency Transactions Framework will be developed to implement the LCT plan.
Earlier, Thailand and Malaysia agreed to launch the Local Currency Settlement Framework (LCSF) in March 2016—allowing businesses in either country to source baht or ringgit from banks in their home country to settle bilateral trade transactions. In 2018, Indonesia joined the LCSF which was expanded to cover investment transactions as well.
More recently, the central banks of Indonesia, Malaysia, Singapore, and Thailand have implemented a contactless QR-code-based local currency payment system for residents in those countries—payments can be made in the local currency from the digital wallet of the sender in one country and received in the local currency of another country with the exchange carried out through the central banks involved, without using the USD or RMB as an intermediary. The Philippines is expected to join the scheme soon. This arrangement is expected to promote financial inclusion since many people remain unbanked in this region.
The BRICS local currency payment project
The BRICS Summit held August 22-24, 2023 in Johannesburg has agreed to promote the accelerated use of local currencies in cross-border payments among member countries—now being expanded to six new members. Institutional building blocks for this have been under development, such as the BRICS Interbank Cooperation Mechanism (to facilitate cross-border payments in local currencies among banks in the group) and BRICS Pay (a digital payment platform in local currencies). Countries in the group have already had bilateral agreements to use local currencies for cross-border payments.
Weighing the costs
Arrangements to use local currencies to settle bilateral trade and investment transactions have proliferated recently. ASEAN has pioneered the development of a plurilateral local currency cross-border payment system—involving more than two countries. These efforts will likely be broadened in the future as the technology to do so can be disseminated to other countries which want to use their currencies in international transactions.
The growing use of a variety of local currencies in cross-border settlements has so far made only a small dent in the pervasive use of the USD in global payments and does not (yet) represent a serious challenge to the USD’s premier role. Nevertheless, the local currency trend has led to a fragmentation of the global payment landscape with identifiable costs—which together with the overall economic fragmentation could take up to seven percentage points off the global output.
It will take time to weigh the perceived benefits versus the costs of using local currencies in cross-border settlements. If the benefits are seen to outweigh the costs, such efforts will intensify at scale. Otherwise, they will basically be driven by geopolitical calculations—and mainly used to de-risk countries’ exposures to US sanctions and the international effects of US economic management.