Would Gradual De‐Dollarization and More Financing in Local Currencies Boost Trade?
| DOI | http://doi.org/10.1111/1758-5899.12712 |
| Published date | 01 September 2019 |
| Date | 01 September 2019 |
| Author | Harald Hirschhofer |
Would Gradual De-Dollarization and More
Financing in Local Currencies Boost Trade?
Harald Hirschhofer
The Currency Exchange Fund (TCX), The Netherlands
Abstract
The article summarizes arguments in favor of de-nominating trade finance in local currencies. By reducing exposure to policy
developments in reserve currency countries and improving the allocation of currency risk with the help of global currency risk
markets will have a positive long-term impact on stability, trade volumes, and growth.
The fairness, sustainability and benefits of global trade have
been moved centre stage in the global political debate. Pro-
tectionism is on the rise and the multinational approach to
solving disputes has been put into question. Against this
increasingly conflictual background, one important aspect of
global trade has received relatively little attention. Today,
global trade is mostly denominated and financed in US dol-
lars and a few other hard currencies.
The dominance of hard currencies, and of the US currency
in particular, has of course historic and good reasons. In
past decades there were simply no or very few alternatives
to financing trades in hard currencies. Adequate long-term
loans in emerging market or even frontier market currencies
were simply not available on a reliable and adequate basis.
Today, this situation has fundamentally changed and long-
term loans in local currencies are increasingly becoming
available. Eichengreen et al, (2012) have pointed out that
history suggests that network externalities, first-mover
advantages and inertia matter, but they do not lock in inter-
national currency status to the extent previously thought. A
shift away from a unipolar dollar-based system could occur
sooner than often believed, driven by local financial market
deepening and stability oriented macro-prudential policies
and tools.
This brief contribution makes the case that we should
build on the existing momentum to strengthen such driving
forces and gradually shift trade financing into local curren-
cies. In this effort, the export credit agencies (ECAs) and
development finance institutions (DFIs) will have an impor-
tant catalytic role.
The advantages of local currency financing
There is increasing evidence of negative side effects of trade
dollarization. Boz et al. (2017) pointed out that whenever
the US currency appreciates against the rest of the world by
one per cent, a 0.6 to 0.8 per cent decline in global trade is
predicted within the next year. There is a clear and strong
relationship between trade prices and the dollar exchange
rate but much less with the bilateral exchange rate between
importers and exporters. For example, a Rwandan exporter
to Kenya may suffer because Kenyan clients will consume
less because the price of the import measured in the cur-
rency they earn as income has become more expensive due
to events in the US. Putting it differently, by using the US
dollar as common denominator, both the Rwandan exporter
and the Kenyan importer/consumer are unnecessarily expos-
ing themselves to shocks and policies in the US. Such defer-
ence to a third party may make sense when this party is
perceived as acting as global guarantor of an international,
global trade system, but may make less sense if the third
party very explicitly puts its own national interests first. Such
considerations are especially relevant amidst the ongoing
tightening of the US Federal Reserve to fight inflation
against the background of a strong economy, record low
unemployment and continuing strong fiscal impulses,
including massive increases in US government spending.
There is also an important sustainability argument in
favour of local currency financing. It has to do with risk per-
ception and management capacities, both on the individual
firm and the macro(-prudential) level. Currency depreciation
risks are often underestimated. Observers too often look at
the immediate past. In contrast, if Reinhart and Rogoff
(2008) showed that currency depreciations of more than 15
per cent have occurred with worrying frequency (Figure 1).
The big advantages of local currency financing are (1) that
it makes macro risks more transparent and (2) it shifts the
exchange rate risks away from the borrowers. Local currency
interest rates incorporate a premium to compensate domes-
tic and foreign investors for inflation and depreciation risks
in the local currencies in which funded projects, firms, and
households earn their income. Because of enhanced risk
awareness, borrowers and investors have a better chance to
avoid unprofitable and unsustainable investments. This
informational advantage even holds, if borrowers should
ultimately still decide to speculate and expose themselves
to currency risk by borrowing in a foreign hard-currency, as
long as a sufficiently transparent local currency yield curve
Global Policy (2019) 10:3 doi: 10.1111/1758-5899.12712 ©2019 University of Durham and John Wiley & Sons, Ltd.
Global Policy Volume 10 . Issue 3 . September 2019 435
Special Section Article
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