Propelled by a strong post-pandemic recovery in the US, sticky inflation, and geopolitical tensions, a surging dollar has battered almost every Asian currency. The changing expectations that the US Federal Reserve (Fed) might delay its anticipated rate cuts in the wake of stronger March inflation numbers and lingering conflict in the Middle East are causing home currencies to tumble across Asia and capital to outflow.

Last week, Bloomberg reported that all but one of the 23 developing nation currencies it tracks have dropped against the greenback this year. The Japanese yen plummeted over nine per cent falling to its weakest in 33 years, while the Korean won weakened by 6pc hitting its lowest level in eight years.

India’s rupee and Vietnam’s dong are also at their weakest ever. Likewise, the Indonesian rupiah has been at its softest in four years, and the Malaysian ringgit has been close to its weakest ever since the 1998 Asian financial crisis.

The pain caused by a strong dollar, along with the 23-year high interest rates of 5.25pc to 5.5pc, is compelling governments and central bankers from Japan and Indonesia to Vietnam and elsewhere to intervene in foreign exchange markets, raise interest rates or issue warnings to prop up their currencies as importing US inflation via their weaker currencies becomes problematic for their economies.

Pakistan must diversify its reserves to move away from dollar dependence amid global crises and disrupted supply chains

Ongoing developments suggesting that the Fed will delay rate cuts have made Asian currencies plummet even faster in recent weeks. “The rampaging dollar and the prospect of higher-for-longer US interest rates have been the main drivers,” wrote India’s The Economic Times.

Though the Pakistani currency has remained unaffected by the anticipated delays in the US rate cuts, higher Fed rates are one of the key factors keeping the State Bank of Pakistan (SBP) from lowering interest rates despite falling inflation numbers.

As recently noted by economist Ahmed Jamal Pirzada, this development is not encouraging for Pakistan. He explained that if Pakistan’s interest rates stray too far from what advanced economies are doing, it could weaken the Pakistani currency and erase recent progress on inflation. The ongoing Middle East conflict adds another layer of complexity, potentially forcing Pakistan’s central bank to raise interest rates even further.

No wonder most analysts don’t expect the SBP to cut rates in today’s Monetary Policy Committee (MPC) meeting despite the third consecutive fall in the inflation rate to 20.7pc last month — the lowest since May 2022. The MPC meeting comes amid media reports that the SBP has bought $5.5bn to bolster the rupee during the current financial year.

Meanwhile, Karachi-based brokerage firm KTrade’s new report, ‘Assessing the Future Trend of the US Dollar & Global Currency Flows’ has predicted that the value of the dollar is likely to go through a downward cycle in the next few years, considering the pressure from both fiscal and current account deficits and an anticipated combination of expansionary monetary policy and restrictive fiscal policy in sight.

In the absence of two key growth drivers — the unprecedented surge in the US fiscal deficit and the depletion of surplus savings — propelling the US economy in 2023 could slow down growth as consumption decelerates and business investments weaken.

The report projects the US Dollar Index (DXY) — a measure of the dollar value against a basket of six major currencies — to decline from 102.4 to 96-96.2 by 2028, expecting the Fed to start interest rate cuts sometime this year.

“T-bill issuance has increased by 125pc since 2019 while reserve balances are up 118pc. Therefore, interest payments on T-bills and reserve balances, together, are putting pressure on the US economy, which will prompt the Fed to ease its monetary policy stance in the next couple of years,” it says.

Furthermore, the report predicts that the already exorbitant prices of gold and bulk commodities might remain high as “central banks diversify away from the dollar to alternative systems and countries strive to become self-reliant and competitive in green transformation amid the disrupted global supply chain”.

Nearly 40pc of the world would be under sanctions if China was sanctioned

Critically analysing the dollar’s dominance as a store of value and global reserve currency, the reports says that the greenback remains dominant as its share in official foreign reserves, global trade invoicing, international debt securities and cross-border loans is many times greater than the US’ share in the global GDP and international trade.

However, this dominance is now being challenged by the growing use of local currencies by many countries, particularly by the BRICS bloc, for conducting international transactions and trade invoicing to avoid impacts of dollar volatility such as seen recently on the value of national currencies and foreign capital flows.

Diversifying official foreign exchange reserves into currencies other than the dollar would provide further impetus to these trends. The dollar comprised 59pc of the disclosed global official foreign reserves in 2023, far surpassing all other currencies, but still less than its 71pc share in 2000.

Moreover, 20pc of the global oil transactions in 2023 were conducted in other currencies, notably as Russia and Iran supplied cargoes to different purchasers. “This strategy mitigates the risks associated with exchange rate fluctuations and reduces dependence on dollar-denominated transactions, aligning with broader efforts to fortify economic cooperation within the BRICS framework,” the report notes.

Speaking with a correspondent from London, KTrade Chairman Ali Farid Khwaja noted that central banks and policymakers are looking to diversify away from the US dollar for international financing as direct and secondary sanctions implemented by the US increase the risks of holding assets or raising finance in dollars.

“The message is loud and clear. The use of the dollar as a policy to implement sanctions has been the most damaging factor as 28pc of the world’s GDP is under sanctions, which is big enough for these countries to start thinking about using their own currency,” he said.

“The rise of the US economy is based on its practice of, and people’s belief in free markets. Unfortunately, recent political measures such as protectionism, trade obstructions and infringement of corporate property are breaking the fundamentals — the confidence in capitalism is broken.

“China could be the next to face sanctions, and if that happens, then the size of the world’s GDP under sanctions would increase to 40pc. Today, if I am a country, if I am one of the emerging markets in the Global South, I’ll be worried if I will be the next Russia or face the same kind of trade barriers as China is currently facing,” he remarked.

Mr Khwaja says Pakistan faces similar risks to exchange rate and capital flows as being confronted by other Asian economies due to dollar dominance. “Pakistan must gradually move towards diversification of its reserves. Finance Minister Muhammad Aurangzeb talked about this when he outlined plans to issue Panda bonds to raise debt from the Chinese market in yuan.”

Nevertheless, he admits that it is not easy to break out of dollar dominance. “Can the Global South successfully challenge the Western economic hegemony? This is the biggest question being asked. Moving away from the US presents technical, operational, and political challenges for economies like Pakistan.

“The prudent way for Islamabad to become part of consortiums like BRICS is to take collaborative action by bolstering its trade with Asian nations and the Global South.”

Published in Dawn, The Business and Finance Weekly, April 29th, 2024