Many economies across the world are gradually shifting away from their acute reliance on the US dollar. De-dollarisation is an ongoing trend.

After the Russian invasion of Ukraine that has strengthened the Yuan and the ruble against the US dollar, there has been a wave of de-dollarisation.

Since the Bretton Woods agreement, the US dollar has been used as a medium of exchange in international exchanges. Globally, around 59.8 percent of the foreign exchange reserves are kept in US dollars and 19.7 percent in the euro.

Navigating this tricky landscape requires a clear view of the economic future. There is a need to prioritise production over consumption, foster export-oriented industries and strategically leverage technology for domestic value creation.

Like some other emerging economies, Pakistan is currently exploring various avenues to reduce its dependence on the US dollar. However, its economy is heavily reliant on imports and foreign aid. This making it more vulnerable to external shocks.

In 2022, Pakistan’s import bill stood at a staggering $80 billion and its exports at roughly $31 billion. This reliance on imports exposes Pakistan to the dangers of fluctuating exchange rates and currency manipulation, making it susceptible to economic crisis and instability. The purpose of switching to alternative currencies is to strengthen our ties with the neighbouring countries and to have a more effective monetary policy.

The main focus in Pakistan is currently on the Chinese Yuan. Recently, under a currency swap agreement with China, $4.5 billion – equivalent to 30 billion RMB – worth of import payment was made in Chinese currency. The government is interested in raising this figure during the current fiscal year. Similarly, in June 2023, the payment for the first consignment of Russian oil was made in Chinese Yuan. Pakistan has also signed a memorandum of understanding with China to adopt RMB as an interchangeable currency.

Currency diversification, while a challenge in its initial stage, can help us create a more resilient and self-sufficient economy by ending our over reliance on the US dollar. The concept is relatively new for Pakistan which is also experiencing other challenges. Therefore, it is important to understand the implications of bold steps in this direction before we take a leap.

A shift away from the US dollars may seem like a win-win situation on the surface as it can help strengthen the domestic currency and reduce imported inflation. However, it also has a down side. Let’s take a look at what happens if we shift to the Yuan or another alternative currency for international trade. Suppose we choose the Yuan. Most of the payments, especially in trade with China, will then be paid for in Yuan.

According to the State Bank of Pakistan, in 2022 trade with China stood at $20.08 billion. Out of this the imports stood at $17.3 billion and the exports at $2.78. Pakistan’s overall trade deficit in FY2022 was $39.04 billion. It is this balance of payments deficit that creates a demand for an alternative currency like the Yuan, leading to the devaluation of rupee.

Pakistan is highly indebted and unlikely to get out of this situation in the near future. Around 83.55 percent of the country’s external debt is dollar oriented and less than 10 percent in euro or British pound.

Like some other emerging economies, Pakistan is currently exploring various avenues to curtail its dependence on the US dollar. However, it is heavily reliant on imports and foreign aid. This makes it more vulnerable to external shocks. 

The exchange rate for the Chinese yuan or another currency like the Russian ruble is currently determined based on US dollar. So even if we adopt the Chinese yuan as a medium of trade, we must pay the debt in US dollars.

Unless our lenders are also making a simultaneous shift, it will be hard to persuade them to accept debt repayment in a currency other than the dollar. This is also true of our trading partners. We can therefore somewhat reduce our reliance on the US dollar but not shift completely. Also, we will need to maintain considerable reserves in two currencies — US dollars and Yuan.

Post-Covid currency value losses have made digital/ crypto currencies and precious metals attractive to many countries. These also have the potential to bolster the ongoing de-dollarisation.

Crypto’s decentralisation promises financial inclusion and an armour against inflation. Precious metals, long considered safer, resist inflation through their limited supply. However, crypto’s volatile nature and hazy regulations raise concerns. The precious metals’ lack of utility makes them vulnerable to sentiment-driven bubbles.

The path to economic stability through these alternatives is intricate and dependent on specific implementations, shifting regulations and the global economic tapestry. Careful consideration, in-depth research and expert guidance are crucial before nations embark on this journey.

Undeterred by the challenges, Pakistan has begun taking early steps towards digital currencies, through various such as Central Bank Digital Currency Research, Blockchain Pilots and some private sector ventures.

Massive de-dollarisation seems unattainable for Pakistan, at least for the short and medium term. Irrespective of our choice of currency for trade and finance, our currency will continue to depreciate unless we have production and trade surpluses. Foreign investment, trade and remittances are the three major source of foreign reserves. Currently, Pakistan is lagging in all three.

Over time, the trade deficit has widened. Unguaranteed long-term policy frameworks are limiting foreign investments in the country. In 2020, Pakistan was ranked 108 out of 190 economies for ease of doing business. The remittances have also been less than the actual potential.

A lot of groundwork is needed to pull-off even a partial de-dollarisation. First, there is a need for a robust framework to chart a clear economic course, perhaps through a charter of economy that can also help mitigate the issue of political instability.

Second, Pakistan needs to focus on becoming an export-led economy. To this end, the state has started work on encouraging major brands to set up manufacturing plants in Pakistan. This goes hand-in-hand with transitioning from a mostly consumer economy to a producer economy.

Third, long-term policy reforms are needed to attract investment.

Fourth, the State Bank needs to take viable measures to control the currency prices in the open market. It must help build resilient financial and insurance mechanisms to fight market volatility.

De-dollarisation has positive implications for big players worldwide such as the BRICS and OPEC+ countries. It may even have a positive impact on Pakistan’s economy in the long term, especially in terms of stabilising and expanding the economy and combating external shocks. However, the country is in no position currently to adopt a rapid de-dollarisation policy.

The writers are researchers at the Sustainable Development Policy Institute. They can be reached at umarayaz406@gmail.com and salmandanish91@gmail.com