Countries around the world have been working to reduce their reliance on the use of the United States dollar for the past few decades.

This concept has been described as de-dollarisation.

The U.S. dollar currently dominates the world as the most used currency in the world for international trade and financial transactions. It is also used as the principal reserve currency.

De-dollarisation, mostly associated with the BRICS nations (Brazil, Russia, India, China and South Africa), began as a response to constant threats of dollar sanctions and trade wars.

Bretton Woods Agreement

Following the end of the Second World War, 44 countries met in Bretton Woods, New Hampshire in the United States in 1944 and negotiated the 'Bretton Woods Agreement' with the aim of creating an efficient foreign exchange system.

Under the Bretton Woods system, Gold was used as the basis for the U.S. dollar, while other currencies were pegged on the value of the dollar.

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In currency pegging, a country ties its currency exchange rate to that of another nation whose currency is already stable, with the aim of achieving currency stability.

The Bretton Woods Agreement did not only establish a gold standard system that transformed the US dollar into a reserve currency, it also created the International Monetary Fund (IMF) and the World Bank.

Presently, these two institutions are still waxing stronger despite the collapse of the Bretton Woods system in the 1970s. The IMF currently has 191 member countries and offers global monetary support, while the World Bank provides loans, grants and technical support to governments.

What’s behind de-dollarisation?

Many countries, developing ones in particular, have been grappling with the ripple effects of the appreciation and depreciation of the dollar, fueling the push for de-dollarisation as countries try to hedge their currencies.

A strong dollar generally harms developing nations, which mostly rely on foreign investment and foreign capital and makes it harder for them to pay their dollar denominated debts.

According to Andrew Mold, Acting Director of the sub-regional office for East Africa at UN Economic Commission for Africa (ECA), an extremely strong dollar left countries in Eastern Africa reeling under the weight of high inflation.

"The recent downward pressure on regional exchange rates has been the product of higher-than-anticipated inflation since 2022, and also an extremely strong dollar,” he said.

"The switch from a global regime of very low real interest rates prior to the pandemic to one where interest rates have been rising is the long term story behind this," he added.

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In Rwanda, the Franc has been falling against the dollar. Data from the National Bank of Rwanda indicates that the Rwandan Franc remained weak against the dollar, depreciating by 3.7 per cent in the first half of 2024.

Other regional currencies were also not spared, including the Kenyan shilling and the Ethiopian Birr, which experienced a sharp decline against the dollar in the first half of the year.

Apart from currency fluctuations, the de-dollarisation agenda has also been propelled by the imposition of sanctions.

According to experts, the imposition of sanctions on Russia&039;s Foreign Exchange reserves in 2022 by the U.S, triggered the fear that the dollar’s global dominance is being 'weaponised' and used as a foreign policy tool.

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In response, central banks are looking to diversify their foreign exchange holdings, with many of them buying more gold, a fact that has been proven by the decreasing dollar share of foreign exchange reserves.

According to recent report by J.P. Morgan, the largest bank in the U.S., states, the dollar's share of FX reserves, the most commonly analyzed barometer of dollar dominance, has decreased, notably in Emerging Markets. Central bank FX reserves are typically held in U.S. dollars, but the latter is now being supplanted by other currencies.

Impact on trade

According to Churchill Ogutu, an economist at IC Group, de-dollarisation could help boost trade, especially in Africa.

"De-dollarisation will help facilitate trade by eliminating the need for a third currency and easing cross border payments," Ogutu said.

Ogutu added that although getting a replacement for the dollar is still a challenge, countries on the continent are already making efforts to find alternatives, citing the Pan-African Payment and Settlement System (PAPSS) that has enabled cross border transactions in Africa using local currencies and reduced the demand for foreign exchange liquidity.

Over 70 per cent of Africa's total public external debt is dollar denominated.

According to Ogutu, de-dollarisation will give borrower countries a pool of other currencies to choose from.

"In the event that de-dollarisation is successful, countries will now have a more diverse currency basket to choose from other than the dollar and find a way to balance their borrowing portfolio from a currency perspective," he noted.

Ogutu argued that the dollar cannot be easily washed away, especially being a reserve currency and being among the IMF's Special Drawing Rights currencies.

"Its dominance, though challenged, will continue at least for the next decade or more," he said.

The J.P. Morgan report holds the same opinion. "The dollar’s role in global finance and its economic and financial stability implications are supported by deep and liquid capital markets, rule of law and predictable legal systems. Meaningful erosion of dollar dominance is likely to take decades.”