De-dollarization is the process of replacing the U.S. dollar as the main currency used for the trade and exchange of goods and services between a country and its most important trading partners with either the country’s domestic currency or a third country’s currency.
Over the years, many countries have been trying to reduce global dependence on the U.S. dollar. According to experts, there are several underlying reasons behind this trend. First, there is growing discomfort with the U.S.’ behavior in the international arena, especially its use of economic sanctions. The sanctions imposed on Russia by the U.S. and its allies following Russia’s invasion of Ukraine, including the freezing of Russia’s foreign currency reserves and its exclusion from the SWIFT system, have alarmed large reserve-holding countries, most of which are emerging economies from the Global South.
Second, there is a deepening concern among countries that the dollar may no longer be a safe store of value due to the U.S.’ economic practices, especially its high level of spending and ballooning national debt, which is nearing $32 trillion and is projected to reach $44 trillion by 2027. A quarter of the U.S. debt is owned by foreign countries and many of them are no longer willing to increase their holdings of U.S. debt. In 2022, Japan and China, the two largest holders of U.S. Treasuries, reduced their holdings by a combined $400 billion.
Third, in response to the U.S. Federal Reserve’s recent aggressive interest rate hikes to fight domestic inflation, many central banks around the world have raised interest rates to stem capital outflows and the sharp depreciation of their own currencies. More specifically, when a country’s central bank raises interest rates, it makes it more expensive for businesses and consumers to borrow money. This can make the domestic currency more attractive to investors. This is because a higher interest rate means that investors can earn a higher return on their investments in the domestic currency. Additionally, higher interest rates make it more expensive for businesses and consumers to buy imported goods. This, in turn, can lead to a decrease in demand for imported goods, which can help to reduce the trade deficit and increase the country’s holding reserves. Countries can then diversify their holding reserves into a more multi-currency portfolio to diversify risk. Moreover, as developing countries are already struggling in the post-Covid era and in the context of the crisis in Ukraine, they are turning to local currency trade—a type of cross-border trade that is conducted in local currencies, rather than in a global currency like the U.S. dollar—to preserve their hard-earned cash flow in order to prevent future distress.
The de-dollarization movement in Asia
There are a number of measures that can foster de-dollarization, which range from market-based measures that provide incentives to reverse currency substitution to measures that prohibit or strictly limit the use of foreign currency (forced de-dollarization). A popular method adopted on the Asian continent is that of local currency trade (LCT). LCT is a type of cross-border trade that is conducted in local currencies, rather than in a global currency like the U.S. dollar. Sixty countries today are engaged in trading in their respective currencies. The July 2023 rupee-based trade agreement between Bangladesh and India is an example of LCT. The agreement allows Indian and Bangladeshi businesses to trade in Indian rupees, and eventually in Bangladeshi takas, rather than in dollars. The ASEAN union has been working to facilitate LCT. At the 42nd ASEAN Summit in May 2023, members signed an agreement to push for better regional payment connectivity and the use of LCT. The move is seen as the bloc’s strategy to transition away from established currencies used for trade, such as the U.S. dollar. Through LCT, ASEAN is expecting to increase trade within the bloc, deepen regional financial integration, strengthen financial resilience, and bolster regional value chains.
China and Malaysia’s proposal to establish an Asian Monetary Fund (AMF) to reduce the continent’s dependence on the dollar and the International Monetary Fund (IMF) is another approach to advancing de-dollarization that has taken shape in Asia. The AMF would allow Asian economies to pool regional currencies that they could then draw upon in a crisis, instead of relying on the IMF, which uses the dollar. The biggest problem with the AMF idea is that a similar institution already exists; the Chiang Mai Initiative Multilateralization (CMIM) was initiated in May 2000 but has never been leaned on to resolve a crisis. Additionally, Indonesia has responded cautiously to the idea of creating the AMF as a means to reduce Asia’s dependence on U.S. dollars. Instead, the country has advocated for the use of concrete policies to de-dollarize, such as the use of local currency settlements (LCS). LCS refers to the final payment for a trade transaction in the local currencies of the trading partners (a similar concept to LCT, which refers to the actual exchange of goods and services between two parties in their respective local currencies).
Finally, another approach to de-dollarization that is under consideration in Asia is the creation of a new reserve currency. Specifically, the BRIC nations, which include China and India, have been discussing the possibility of creating a new currency for several years. The goal of this currency would be to reduce the reliance of the BRICS countries on the U.S. dollar in international trade and finance.
How Indonesia is embracing de-dollarization
Since 2017, Indonesia has collaborated in the settlement of trade transactions using local currency with a number of trading partners. The Bank of Indonesia (BI) signed several agreements on LCS cooperation, including with Thailand and Malaysia in 2018, with Japan in 2020, with China in 2021, and with South Korea in 2023. These LCS agreements will allow these countries to conduct bilateral transactions in their own currencies, instead of the common practice of using the U.S. dollar.
BI sees LCS expansion as critical to reducing domestic dependency on major global currencies and creating rupiah exchange rate stability. Thus, the bank plans to expand LCS cooperation to include other important trade partners such as Singapore, India, and Saudi Arabia. Moreover, BI plans to expand the scope of its trade agreements from LCS to LCT, that is, from trade settlement and investment only to also covering cross-border payment as well as money market transactions.
Even though there are LCS agreements in place between Indonesia and a number of countries, the use of local currency is not mandatory in every bilateral transaction. Instead, it depends on the inclination of the seller and the buyer who may decide that the U.S. dollar is a better fit for their needs.
Despite the growing level of attention that de-dollarization has garnered, the U.S. dollar continues to be the most used currency in Indonesian export-import trade. In the last 15 years, more than 80 percent of Indonesia’s import trade and 90 percent of Indonesia’s export trade were conducted in U.S. dollars. In 2022, Indonesian trade transactions using U.S. dollars reached USD 259.17 billion for export and USD 186.67 billion for import. This is a hundred times higher than trade using the yuan, Indonesia’s second most used currency for trade, for which the value of trade is equivalent to USD 3.16 billion for export and USD 10.23 billion for import. However, even though the yuan only accounts for one to four percent of Indonesia’s trade flows, transactions using the yuan experienced a significant annual average increase of around 40 percent between 2018 and 2022, in line with the increasing levels of trade between Indonesia and China, which has been growing steadily over the years.
The prospect of de-dollarization
As a result of Indonesia, Asia, and the broader world’s efforts to de-dollarize, the U.S. dollar has suffered a significant decline in its market share as a reserve currency. In fact, the IMF noted that between 2000 and 2022, the U.S. dollar lost approximately 13 percentage points in its market share of the world’s international reserves, going from holding a 71.14 percent market share to holding a 58.36 percent market share.
While it is clear that the process of de-dollarization has gained momentum in the last few years, there is consensus among experts that the U.S. dollar will not be replaced as the world reserve currency and primary currency used for trade in the near future, mainly because there are no viable near-term replacements.
Currently, the U.S. dollar is still the dominant currency for international transactions. According to the Bank for International Settlements (BIS), 88 percent of foreign exchange transactions use the dollar. Additionally, the BIS has found that approximately 50 percent of global trade is invoiced in U.S. dollars, even though the U.S. only represents about 10 percent of global trade. Similarly, in the second quarter of 2022, the amount of debt and loans denominated in U.S. dollars where neither the borrower nor the lender was a U.S. resident was estimated to represent 88 percent of total international U.S. dollar-denominated debt and 65 percent of total international U.S. dollar bank loans. Shifting to other currencies for global transactions is not likely to happen anytime soon due to the massive changes that would be required.
The U.S. dollar still offers several benefits that other alternatives cannot. The size and stability of the U.S. economy coupled with the ease with which the dollar can be converted are not found anywhere else. These features are at the core of the choice of the dollar as the main currency for foreign transactions and foreign reserve accumulations. Many economists and political scientists believe that the dollar’s dominance is not currently under threat, and speculations regarding the fall of the dollar are often exaggerated.
Dr. Renata Simatupang is Chief of Party of USAID/Indonesia’s Economic Growth Support Activity (EGSA); Akbar Dachlan is EGSA’s Economic Researcher; and Galuh Maharani is EGSA’s Research Associate.
 Source: IMF Data; own calculations.
 This number is out of 200 percent given that foreign exchange transactions include two currencies.