The recent Russia-Ukraine conflict has highlighted that countries can be totally cut off from the global financial system, and the dollar reserves they have painstakingly built could become worthless overnight. This is likely to accelerate the move away from the dollar and toward alternative assets and payment systems.
Besides the imbalances in the dollar based global financial system that have been noted for some time, we now see the impact of the weaponization of the dollar on a global economy and world power. While this is an on-going threat, and countries over the last two decades have been seeking ways to diversify their financial systems, the speed and severity of the sanctions imposed on the Russian Central Bank and the closure of SWIFT to the country has emphasized how necessary access to the dollar is.
Overnight, Russia has been brought to a financial standstill, and citizens’ savings wiped out with the dramatic fall in the rouble, down 50% against the dollar since the start of 2022.
What are the implications for ASEAN+3 economies?
One of the concerns some countries may have is that the international sanctions imposed on Russia today could also be applied to them in future, leaving their large dollar reserves inaccessible and valueless. Accordingly, moves toward supporting alternatives to the SWIFT messaging system are likely to grow.
At present, China has a Cross-Border Interbank Payment System (CIPS), an independent international yuan payment and clearing system connecting onshore and offshore clearing markets and participating banks, which was launched in 2015. With 1,280 users—75 directly participating banks and 1,205 indirect participants—across 103 countries, its use has been boosted during the Belt and Road Initiative. Russia’s own messaging and payment system –the System for Transfer of Financial Messages (SPFS) – has around 400 users and a dozen foreign banks from countries such as China, Cuba, Belarus, Tajikistan and Kazakhstan. Both CIPS and SPFS pale in comparison to SWIFT, which is used by 11,000 financial institutions across over 200 countries.
Going forward, some economies may become more open to undertake transactions in alternative payment systems, in addition to SWIFT, in order to diversify their risk of using a single payments network.
Nevertheless, the demand for dollars won’t materially decrease in the short term. And so, what would be interesting is whether CIPS and other payment systems based outside the USA and Europe will also look to build capabilities for transferring payments in dollars or euro. This would offer an alternative to being totally reliant on SWIFT, while still enabling access to dollar payments.
Such a system already exists and has been a key innovation in multi-currency offshore payment systems. The Clearing House Automated Transfer System (CHATS) in Hong Kong, China, is a group of real-time gross settlement systems, each of which settles in HKD, USD, EUR and RMB. This kind of payment system is an ideal prototype that some ASEAN+3 economies may want to consider, perhaps looking to replicate a similar payment system that could be managed in the region.
There are some fundamental challenges to overcome before expanding the use of alternative payment systems, as set out in a paper, Payments Without Borders, by Bech, Farqui and Shirakami, and summarized below:
- Cross-currency payments require an FX conversion, where a balance sheet, and the willingness and ability to manage the consequent market and FX settlement risk are essential.
- There needs to be sufficient intra-day liquidity in the system, which will need to be prefunded.
- There needs to be interoperability between systems to include operating hours, access, clearing and settlement protocols and message standards.
- The management of compliance risks and costs related to anti-money laundering will need to be funded, and rules centralized and managed coherently.
Furthermore, there needs to be a high degree of shared political will among participants. While the ASEAN+3 already have that in terms of promoting regional financial cooperation, it remains to be seen how many countries will be interested in building an alternative payment system. Lastly, there are legal issues to be resolved. Legal gaps which lead to a conflict of laws in managing a cross-border payment system may require new legislation or treaties.
A good starting point may be to launch a feasibility study to consider the issues above and layout a framework on how an alternative integrated regional payment and settlement system could be established and expanded, offering payment and settlement in a range of currencies, including the dollar and euro. To avoid the same risks of weaponization, the focus should be on having a regionally managed system or range of additional payment and settlement options, rather than being overly reliant on any one country.
In the longer-term, shifts away from holding the dollar as a reserve currency will accelerate further, particularly as alternative payment systems become more widespread. Central banks will likely want to shift more of their reserves to gold, held in their own countries, as well as to a wider basket of foreign currencies and assets.
The sanctions on oil and gas sales on Iran and now Russia could accelerate the decline of the petrodollar system. We have seen recently that Saudi Arabia is reportedly in discussions to accept payment for some of its oil in yuan. Whether this will happen in practice remains to be seen, but just the fact that such discussions are now taking place helps to frame this debate. Indeed, if this were to happen to any large extent, it would materially reduce the reliance on, and need for, dollars, and consequently further promote alternative payment systems. Moreover, countries will now be more open to listing assets on a wider variety of exchanges than just those in the USA, Europe and UK, in order to maintain access to markets and funding in case they too face sanctions.
These transitions will not happen overnight, hence the immediate focus should remain on the further rollout of alternate payment systems.
In conclusion, the combination of these moves will feed into the ongoing de-globalization, particularly following the COVID-19 pandemic. Supply chains that were already breaking, are likely to be exacerbated by the Russia-Ukraine conflict and drive the world toward more closed regional trading blocs. It is probable we will see closer trading relationships forming between Canada, USA and Mexico; between the European region, the Nordics and the Balkans; and of course, further integration within ASEAN+3.
For ASEAN+3, this will mean stronger support for regional trade and services, with some economies becoming more open to payment and settlement in currencies other than the dollar. One outcome may be a financial system that has split into two or more separate financial centers, supporting a wider range of currencies and utilizing alternative payment systems, rather than the current global dollar based one. This may well end up being net positive for the world, particularly emerging economies, who will no longer be forced to hold billions in dollar reserves and can instead channel those savings to support their domestic policies.