The Pakistani rupee is expected to end the year on a historic low — as Asia’s worst-performing currency — having shed almost 20 per cent of its value against the US dollar. Even with the authorities clamping down on profiteering, smuggling and banning the imports of ‘luxury goods’, the currency isn’t expected to fare any better next year.

Amid all this, one idea that has been gaining traction in policy circles, not just in Pakistan but among other regional players too, is the need to lessen the dependency on the US dollar. But what does this mean for Pakistan? And is it even doable?

The buzzword

De-dollarisation is no longer a financial buzzword; it is a strategic move by nations to diminish their reliance on the United States dollar (USD) in global trade, transactions, and reserves. In recent times, this shift has been triggered by complex geopolitical dynamics, particularly the Ukraine-Russia conflict and ensuing Western sanctions, reshaping the landscape of cross-border trade and payment systems.

Additionally, aggressive rate hikes by the US Federal Reserve aimed at curbing domestic inflation have further catalysed this global trade transformation. Notably, the USD’s share, on the global scale, declined from 73 per cent in 2001 to 55pc in 2020 and further to 47pc since the initiation of sanctions against Russia.

Amid rising tensions, many nations are increasingly inclined to explore alternative currencies for their trade, investment, and reserves. The quest includes a closer look at the development of alternative multilateral clearing systems, seeking independence from the traditional Society for Worldwide Interbank Financial Telecommunication (SWIFT). Russia and China, in particular, have introduced their cross-border payment mechanisms, providing viable alternatives to the US-dominated SWIFT network.

In the midst of this international shift, Pakistan is not merely a spectator but an active participant in the discourse. Within policy circles, there’s deliberation on the potential advantages and challenges of embracing de-dollarisation.

So, why is this conversation so pertinent for Pakistan now? What urgency does the current global landscape pose for the country? Let’s delve into the intricacies of Pakistan’s strategic considerations in the face of these transformative global financial shifts.

Dollar hegemony in Pakistan’s economic landscape

Pakistan strategically holds USD in its foreign exchange reserves, used for managing the balance of payments, and for facilitating international import payments. While official government financial transactions are primarily conducted in PKR, the USD plays a pivotal role within specific sectors of the economy.

This practice is influenced by two key factors — first, the majority of global energy transactions are conducted in USD, and second, the USD is the preferred medium for cross-border trade settlements.

Unfortunately, the economy’s reliance on the USD has exposed it to significant repercussions from the recent dollar hike. By early September 2023, the dollar surpassed PKR 300, peaking at PKR 308.1 on September 5, 2023.

As of December 2022, Pakistan’s total external debt and liabilities had reached $126.3 billion. Of this, approximately 77pc, equating to $97.5b, comprised direct obligations of the Pakistani government to diverse creditors. This includes multilateral debt from institutions such as the World Bank, Asian Development Bank, IMF, in addition to Paris Club debt, private and commercial loans, and Chinese debt. Additionally, government-controlled public sector enterprises carry an additional $7.9 billion in debt, primarily to multilateral creditors. As a result, around 83.55pc of Pakistan’s external debt is dollar-denominated. In addition, 86pc of Pakistan’s trade is denominated in USD, as has historically been the case, with euro-denominated exports and imports accounting for less than 10pc.

Impact of dollar hegemony

Pakistan’s reliance on the USD has left it vulnerable to significant currency depreciation, near-hyperinflation, diminished import capacity, a growing current account deficit, and declining foreign reserves. Recent data shows a concerning 3.1pc year-on-year growth in Pakistan’s trade deficit. This is largely due to a substantial 7.3pc surge in imports, despite a 12.9pc rise in exports.

To combat currency depreciation, Pakistan implemented measures that included selling foreign exchange reserves to mitigate the decline and restore stability. In a period of six months, the State Bank’s foreign exchange reserves plummeted to $3b in January 2023, a drop of 64.7pc from August 2022. This rapid depletion can be directly attributed to the escalating prices of imported goods, posing a looming threat of bankruptcy if this trend persists.

Additionally, currency devaluation has greatly impacted Pakistan’s monetary policy. With the inflation rate consistently above 27.4pc through August 2023, the State Bank responded by increasing interest rates by 100 basis points to a historic high of 22pc to reduce domestic consumption.

De-dollarisation drive gaining momentum

On March 29, India introduced its latest foreign trade policy, which sanctions the use of rupees (INR) in trade dealings with nations experiencing dollar shortages or currency crises. Following suit, Malaysia has become the most recent country to participate in this initiative.

In July 2022, the Reserve Bank of India (RBI) authorised the settlement of international trade transactions in INR in an attempt to enhance global trade dynamics and cater to the preferences of traders utilising INR. Moreover, India has previously engaged in rupee-based trade with countries such as Russia, Mauritius, Iran, and Sri Lanka.

India has also conveyed its intent to look for an alternative to SWIFT in collaboration with Russia and China. Its inclination toward these systems stems from its aspiration to reduce its reliance on the USD and mitigate the potential vulnerability of being disconnected from the global financial system during instances of US sanctions.

Furthermore, India stands to benefit by diversifying its currency options, fostering stronger financial resilience, and potentially enhancing its economic autonomy in the global arena. This strategic move aligns with a broader trend of countries seeking alternatives to the traditional financial systems dominated by the USD.

Assessing the viability of de-dollarisation in Pakistan

For Pakistan, a potential de-dollarisation strategy revolves around forging closer relationships with neighbouring nations and incorporating regional currencies into its trade mechanisms. Using currencies such as the Chinese Yuan or Dirham for trade can diminish the economy’s reliance on the USD.

An illustrative instance is Pakistan’s recent transition to buying Russian oil in Chinese Yuan in June 2023, a departure from its prior practice of conducting oil transactions in USD. This shift offers several potential advantages, including access to discounted oil and enhanced access to Chinese financial institutions. It also facilitates Pakistan’s capacity to engage in commercial borrowing from these banks, allowing it to redirect a segment of its expenditure for oil imports to Yuan and mitigating its existing dollar shortage.

Moreover, de-dollarisation emerges as a transformative strategy, creating avenues to attract Foreign Direct Investments (FDIs) in various currencies beyond the conventional reliance on the USD. This intentional diversification not only broadens investment sources but also diminishes susceptibility to the uncertainties of currency fluctuations. Actively promoting FDIs in alternative currencies enables Pakistan to move away from a singular dependence, fostering a more stable and resilient investment environment.

Although Pakistan has the potential to capitalise on these evolving global dynamics, primarily due to its strategic alignment with China, it must avoid alienation from the US — a vital ally. Dollar clearly has a large global footprint, with a majority of the global trade invoicing still being conducted in USD. Instead, this situation could be characterised as an opportunistic rivalry among global powers competing to strengthen their economic and political influence. Pakistan must tread carefully to avoid being caught in the crossfire.

The pressing issue lies in the current account deficit, which is financed by various bilateral and multilateral loans, with the IMF being a significant contributor. This strategy has resulted in Pakistan holding a significant portion of its debt in foreign currency, primarily the USD.

Between July and September 2022 alone, Pakistan secured projects and programme loans/grants from a variety of foreign sources. Over 50pc of these funds originated from the IMF, approximately 30pc provided by multilateral partners such as the World Bank and Asian Development Bank and 17pc coming from bilateral partners. Over the past three years, Pakistan’s debt from the IMF alone has exceeded $6b. Shifting away from the USD could disrupt Pakistan’s debt management, potentially jeopardising a substantial portion of vital foreign assistance used during economic crises.

The de-dollarisation debate transcends a mere currency swap, shifting Pakistan’s dependency from the USD to another currency. Instead, it calls for a comprehensive economic policy reform. This shift should serve as a catalyst for promoting self-reliance rather than relying on foreign aid in turbulent times. By fostering self-sufficiency, Pakistan can diversify its currency holdings and reduce its dependence on foreign aid, thereby bolstering economic autonomy and stability.

What next?

Crucially then, it seems that de-dollarisation’s viability is intertwined with Pakistan’s need to reduce its dependence on institutions such as the IMF. Unlike India and Bangladesh, Pakistan has displayed a growing reliance on the IMF to finance its trade deficit.

Hence, despite its reliance on the USD and vulnerability to economic shocks caused by the currency’s fluctuations, Pakistan’s current economic conditions dictate that it should continue to seek support from both the IMF and its Chinese partners, without favouring one over the other. In the absence of substantial debt relief from creditors and a deliberate push to industrialise its exports and enhance the manufacturing of value-added goods, de-dollarisation remains, for now, a distant dream for Pakistan.