The Fed’s hiking cycle has made dollar credit more expensive and scarcer, the Atlantic Council wrote.
China’s yuan has benefited the most, given that its borrowing costs are considerably lower.
For the first time in two decades, it’s considerably cheaper to pursue short-term borrowing in yuan than in the greenback.
The Federal Reserve shares some responsibility for fueling the de-dollarization trend, according to the Atlantic Council.
Though global efforts to wean off the greenback are often framed as a political move to erode US dominance of the financial order, too much focus on this can overshadow economic fundamentals that also play a role.
“Rate hikes by the US Federal Reserve, which coincidentally began to take full effect in the months after Russia’s invasion of Ukraine, have caused borrowing in dollars to become more expensive and scarcer, encouraging emerging market firms to seek dollar alternatives—namely the RMB,” authors Niels Graham and Hung Tran wrote.
Of course, some of the shifts away from the greenback are geopolitically motivated, the think tank acknowledged. Most of it is in response to Western sanctions against Russia that froze Moscow’s currency reserves and largely shut it out of the global financial system.
Other countries who fear similar restrictions, such as China, have been among the biggest proponents of de-dollarization.
But even if the West had not curbed Russia’s finances, emerging markets would still have reason to turn away from the dollar, according to the Atlantic Council.
For the first time in two decades, it has become considerably cheaper to pursue short-term borrowing in yuan than in the greenback, it said. That’s due to the Fed’s steep hiking cycle, which brought interest rates from near-zero levels in 2022 to a range of 5.25%-5.50% in 2023.
Meanwhile, China’s muted inflation allowed it to keep its rates largely unchanged, pushing international firms to take advantage of cheaper, yuan-denominated debt.
The Fed rate hikes also sparked dollar appreciation, with the greenback remaining roughly 10% above its pre-2022 average. Russia’s war only compounded this, as many turned to the dollar as a safe haven asset.
But this has meant that dollar availability became severely restricted, causing borrowers that rely on short-term greenback funding to see a decline in credit, the researchers said.
“Without abundant dollar financing alternatives, such as during the 2008 financial crisis, the impact of this would have subdued global trade. However, following concerted efforts by Beijing to promote RMB-denominated lending, firms seeking short-term finance can now turn to RMB lenders or RMB-denominated debt markets,” the Atlantic Council wrote.
This adoption means that global firms are more willing to adapt to China’s emerging global finance infrastructure, and the use of Beijing’s Cross-Border Interbank Payment System has grown rapidly.
This alternative to the SWIFT system tends to see substantial spikes when dollar availability becomes constrained, the think tank said.
Though the Fed is likely to start its rate cutting cycle this year, the ultra-low interest rates that triggered dollar cost advantages aren’t coming back.
To be sure, the yuan isn’t an ideal currency for international use, given that it’s not a free-floating tender, the researchers noted.
“Even so, in the coming year macroeconomic trends will likely continue to push emerging market firms towards RMB-denominated debt for trade financing in particular, amplifying the use of the RMB in international trade.”