On November 21, 2023, China and Saudi Arabia solidified their economic partnership by entering into a local-currency swap agreement amounting to approximately $7 billion. This move comes at a time when nations in the Middle East and emerging markets are actively seeking avenues to divert a greater portion of their non-oil trade away from the US dollar.
The central banks of both countries formalised a three-year arrangement, allowing for a maximum exchange of 50 billion yuan or 26 billion riyals, as indicated in the statements.
In its ongoing efforts to enhance the yuan’s global role in transactions with major energy and commodity exporters, China stands as Saudi Arabia’s most significant trade partner. The currency swap agreement, facilitated by the People’s Bank of China, is anticipated to fortify financial collaboration and streamline trade and investment between the two nations.
According to the Saudi monetary authority, this agreement mirrors the deepening cooperation between the central banks of China and Saudi Arabia, marking a significant milestone in their bilateral relations. Beyond the economic front, this deal underscores the broader trend of strengthening ties between Beijing and Riyadh.
While Saudi Arabia has traditionally been a primary oil supplier to China, recent years have witnessed an expansion of business relations. Saudi Aramco, for instance, has invested substantial sums in China’s petrochemical sector, and Saudi Arabia is actively courting Chinese tech companies.
A testament to the growing diplomatic relations, Chinese President Xi Jinping’s visit to Riyadh last year resulted in agreements in principle valued at $50 billion. Amidst these developments, it is noteworthy to characterise this agreement as a pivotal step in the direction of de-dollarisation.
As the global landscape shifts and countries seek alternatives to the US dollar in their economic transactions, this currency swap agreement between China and Saudi Arabia emerges as a significant component in reshaping the dynamics of international trade.
The geopolitical and economic landscape has been witnessing significant shifts, prompting speculation about the sustainability of the longstanding dominance of the US dollar as the world’s reserve currency. Several developments, including Saudi Arabia’s impending inclusion in the BRICS grouping, its agreement to sell oil to China in yuan, and strategic agreements between major players like China and Russia, indicate a growing momentum toward de-dollarisation.
In August, Saudi Arabia was invited to join the BRICS group of Brazil, Russia, India, China, and South Africa. Expected to officially join in January alongside five other nations, including Iran, the United Arab Emirates, and Argentina, this move highlights an expanding coalition of countries seeking alternative economic alignments beyond the traditional Western-centric sphere.
The economic ties between China and Saudi Arabia further underscore the shifting dynamics. Despite Russia being China’s top oil supplier, Chinese customs data from 2022 revealed that China imported $65 billion worth of Saudi crude oil, constituting approximately 83% of the country’s total exports to China. This substantial reliance on Saudi oil, coupled with the forthcoming inclusion of Saudi Arabia in BRICS, contributes to the narrative of a diversifying global economic landscape.
The Xi-Putin agreement, initiated in 2014 to promote trade and investment between China and Russia using their own currencies—the yuan and the ruble, respectively—further emphasises the trend of reducing dependence on the US dollar. Saudi Arabia’s willingness to sell oil to China in yuan adds another layer to this narrative, as it signals a departure from the traditional practice of oil transactions being predominantly conducted in US dollars.
China’s proactive approach toward de-dollarisation is evident in its agreements with Saudi Arabia and other nations. The signing of a currency swap agreement with new BRICS member Argentina earlier this year and a similar pact with Brazil in 2013, aimed at safeguarding against future global financial crises, underscores a broader strategy.
Moreover, in January 2023, Russia announced the launch of a new Chinese yuan currency swap instrument, reflecting the growing volume of transactions between the ruble and yuan. The daily maximum volume for this instrument was set at 10 billion yuan ($1.48 billion), demonstrating a deepening financial integration between major players.
Over the course of several decades, a consistent trend has emerged, showcasing a decline in the willingness of central banks to maintain high concentrations of dollar assets within their reserves. In the late 1970s, the US dollar commanded a robust 85 per cent share of global reserve currencies. However, by the close of 2022, this dominance had receded significantly to a mere 58.4 per cent, as per data from the International Monetary Fund’s (IMF) Currency Composition of Official Foreign Exchange Reserves (COFER).
Although there was a marginal uptick to 59.02 per cent in the first quarter of the following year, this shift is noteworthy as it signifies a sustained decrease in the US dollar’s share of global reserves over the long term. While the US dollar continues to outpace other currencies, notably the euro, which holds a 19.77 per cent share, there is a consensus that the trajectory of the US dollar’s share in reserves is unmistakably downward.
The IMF’s data reveals an 8 per cent contraction across all reserves during 2022, with the pivotal factor being the 9 per cent reduction in the US dollar’s share throughout the same period. This observed decline raises questions about the enduring appeal and stability of the US dollar as the predominant global reserve currency.
Saudi Arabia, the world’s largest oil exporter, has been a foundational pillar of the petrodollar system since its establishment in the 1970s. This system relies on pricing crude exports exclusively in the US currency. While Saudi Arabia has traditionally maintained a peg to the dollar, recent strategic manoeuvres indicate a concerted effort to fortify relations with key trade partners, most notably China, as part of a broader initiative to diversify its economy away from heavy reliance on petroleum.
Despite these efforts to expand economic ties and reduce dependency on oil revenue, Saudi officials have consistently downplayed the notion of the kingdom initiating the sale of its oil to major importers, including China, in currencies other than the US dollar.
The petrodollar system has been a linchpin in Saudi Arabia’s economic framework, and any significant departure from pricing oil exclusively in dollars would mark a substantial shift in global economic dynamics. Notably, oil and closely related products such as diesel, chemicals, and plastics constitute a staggering 90% of the kingdom’s exports. This heavy reliance on the petroleum sector underscores the challenges of diversifying the Saudi economy.
Beyond Saudi Arabia, oil-producing nations such as the UAE and Iraq are actively seeking alternatives for conducting non-oil trade that do not involve the use of the dollar. The endeavour to diminish reliance on the US currency has seen an increased significance in China’s currency swaps. Central banks worldwide have increasingly utilised these swaps, reaching record levels in the current year.
In September 2023, Egypt entered into a local-currency swap agreement with the UAE valued at approximately $1.4 billion. This agreement enables the exchange of local currencies between the two countries’ central banks, with a maximum limit set at 5 billion dirhams and 42 billion Egyptian pounds.
As of the end of September, the outstanding balance of China’s foreign exchange swap lines reached a new peak at 117 billion yuan, as reported by the People’s Bank of China (PBOC). The Chinese central bank currently maintains 29 active swap agreements, collectively amounting to a quota exceeding 4 trillion yuan.
One particularly significant move, laden with symbolic importance for the potential trajectory of global commodities trading, was the successful completion of China’s inaugural yuan-settled LNG (liquefied natural gas) trade. Facilitated through the Shanghai Petroleum and Natural Gas Exchange (SHPGX), this historic transaction involved the national oil company CNOOC (China National Offshore Oil Corporation) and France’s Total Energies SE. The completion of such trade marks a notable step in China’s efforts to broaden the scope of international transactions settled in yuan, showcasing its growing influence in the global commodities market.
Signs of de-dollarisation are evident in the oil markets as well, indicating a diminishing influence of the US dollar on global oil prices, notes Natasha Kaneva, Head of Global Commodities Strategy at J.P. Morgan. Traditionally, there has been a negative correlation between the dollar and oil prices, with an appreciation of the dollar leading to increased imported oil prices and reduced demand, particularly in emerging market (EM) economies. However, a notable shift is observed as more oil transactions occur in non-dollar currencies, such as the renminbi.
Crucially, Russian oil is now being sold in the local currencies of buyers or in currencies of nations perceived as friendly by Russia, according to Kaneva. As an example, certain Indian refiners are opting to pay in dirhams for Russian oil acquired through Dubai-based traders, while others are contemplating utilising yuan for these transactions. Reports indicate that Saudi Arabia is exploring accepting payments in currencies other than the dollar. Moreover, significant Russian commodity producers have ventured into issuing yuan-based bonds.
In September 2022, the state-owned oil company Rosneft conducted a public offering of 10 billion yuan in bonds, followed by a second tranche of 15 billion yuan in March 2023. This signifies a noteworthy shift away from the traditional dominance of the US dollar in oil transactions and financial instruments within the commodities market.
So, is the supremacy of the US dollar truly diminishing? According to data from J.P. Morgan Research, a notable shift is observed. Between 2005 and 2013, a 1% appreciation of the US trade-weighted dollar (USNEER) resulted in a roughly 3% reduction in the price of Brent crude. However, between 2014 and 2022, this correlation weakened substantially to a mere 0.2%, indicating a diminishing impact of the dollar on oil prices. Instead, OECD oil inventories have assumed a more prominent role in influencing oil prices during this period.
The overall trend suggests a significant decline in the importance of the US dollar from 2014 to 2022, challenging its historical dominance in shaping oil prices. The recent agreement between China and Saudi Arabia stands as a noteworthy development reinforcing this shift in dynamics within the global oil market.
