Multi-currency will define the ‘Asian century’

Cross-border financial channels in Asia are experiencing a shake-up as governments and businesses promote, and turn to, local currency pairs and new payment links to execute bilateral trade and investment. 

This small but growing shift is being driven by a potent mix of political motivations, changing economic fundamentals and new technology, ensuring that, over the long term, the ‘Asian century’ will be defined by a multi-currency order. 

Above all, this changing landscape is being driven by surging intra-regional trade. According to research from the Lowy Institute, trade flows between China and the rest of the region are three times greater than those shared with the US. Similarly, trade among the Association of Southeast Asian Nations (Asean) is also booming and is expected to increase over the coming years.

Amid deepening regional ties, the rationale for finding cheaper and more effective ways to conduct this trade is growing.

The dollar loses its shine

For one, the costs and exchange rate risks involved in settling cross-border trade in US dollars have jumped. Haunted by the troubles of the Asian financial crisis in 1997, most regional governments have baulked at the conduct of US monetary policy over the past decade, which has vacillated between super-loose conditions to the ultra-fast tightening of the post-pandemic era. This has played havoc with regional currencies and trading relationships built around the US dollar. 

“Up until recently, [intra-Asian] trade has been mostly invoiced, priced and settled through US dollars and therefore [businesses] have been running a foreign exchange risk through their exposure to the dollar. The tightening cycle by the [US] Federal Reserve so far this year brought home that vulnerability,” says Hung Tran, non-resident senior fellow at the Atlantic Council and former executive managing director at the Institute for International Finance. 

As the Fed has tightened policy, the US dollar index, which measures the strength of the greenback against a basket of other currencies, has shot to multi-decade highs. This has hit consumers and businesses when using local currency to buy foreign goods. Moreover, the cost of executing trade using the dollar involves the doubling of transaction and commission costs, as well as risk, across a trade contract. 

“Therefore, if [countries in the region] can settle and trade among themselves directly using local currency pairs, that will reduce the FX risk because currencies in the region are more stable vis-à-vis each other than between themselves and the US dollar,” says Mr Tran.

Local currency settlement

These developments have not gone unnoticed in regional capitals and work is already underway to achieve this objective. Over the past few years, the growth of local currency settlement (LCS) agreements in Asia have spiked. 

In January 2018, the central banks of Indonesia, Malaysia and Thailand established a local currency settlement framework to promote bilateral trade and investment in local currencies before the Philippines joined one year later. More recently, Indonesia’s central bank signed LCS agreements with China and Japan in 2021. 

Meanwhile, changing trade and consumption patterns are also fuelling a rise in bilateral local currency settlement. This is particularly true in the case of China, which has emerged as a destination for the final consumption of high-end goods in the region. Japanese businesses, for instance, are in some cases using the Chinese renminbi as an invoice currency for trade and investment with Beijing.  

“Some big Japanese companies have changed their settlement currency from US dollars to RMB for their Chinese subsidiaries. So I think that the RMB share of Japanese trade will become larger in the near future,” says Junko Shimizu, professor of international finance at Gakushuin University in Japan. 

Additionally, “some Japanese manufacturing companies with big supply chains in southeast Asia, that export to China, are switching their transaction currency from dollars to renminbi,” she says. 

This comes as China’s efforts to establish bilateral swap lines with economies across the region are bearing fruit. Research from the Atlantic Council’s Hung Tran points to the launch of these agreements with the region’s leading economies, including Indonesia, Singapore and Thailand. Meanwhile, Chinese state news sources, citing research from the Financial Society of Guangxi, note that China-Asean cross-border renminbi settlement volumes are 20 times as big as they were a decade ago.

Risk without regulation

But even with proliferating bilateral local currency settlement agreements, trading and investing through these currency pairs is not without its costs or challenges. 

Some markets remain underdeveloped and lack depth, meaning the expense of transacting through local currencies is also high. What is more, a lack of capital account liberalisation in the region means that the impetus for holding some currencies is low, too, since investment opportunities are limited relative to the US dollar. 

Regulatory changes are required to permit companies and other investors to access the region’s capital markets more easily. “It [might be] impressive to announce that Country A and Country B have established a local currency settlement agreement [and they are] moving away from an over reliance on the US dollar. But it's always important to look at the regulatory framework as well,” says Beomhee Han, group head of the Chiang Mai Initiative Mulilateralization at the ASEAN+3 Macroeconomic Research Office. 

“[From an] Asean perspective, there is an initiative for capital account liberalisation. It has been on the table for a long time, and I believe they are moving in that direction,” says Mr Han. 

Leveraging technology

Some of these challenges, and others, could be solved by the accelerating use of innovative technologies in the region. Over the last 18 months alone, several initiatives and pilot programmes have been launched by regional central banks to promote or test new cross-border financial channels. These developments have the potential to deepen regional economic integration and support local currency settlement on a cross-border basis. 

This includes the launch of new QR code retail payment linkages between key Asean economies. Before long, these connections are expected to evolve to include payments between micro, small and medium-sized enterprises. 

More notable, however, is the increasing use of blockchain-based technology to establish cross-border financial linkages, including the Monetary Authority of Singapore’s Project Guardian. Under the scheme’s first pilot trial, which became active in November 2022, a “live cross-currency transaction involving tokenised Singapore dollars and Japanese yen” was conducted. 

“We have already entered a currency multipolarity era. The incentives to dedollarise have been growing. Digitalisation will enable the use of various national currencies as part of trade and even investment flows,” says Warwick Powell, chairperson of the Smart Trade Networks in Hong Kong and adjunct professor at the Queensland University of Technology. 

The success of mBridge, a cross-border central bank digital currency (CBDC) trial involving the apex banks of China, Thailand, the UAE and Hong Kong, is a case in point. China’s digital yuan was reportedly the most traded and issued token during the experiment. Over time, the development of interoperable CBDCs could potentially ease some of the pain points affecting trade in local currency pairs, even if it also highlights the growing politicisation of finance. 

These initiatives, among others, underline the momentous degree of change that is reshaping cross-border financial channels in the region. Though the US dollar will continue to reign supreme for years to come, the progress being made today points to the development of an evolving trade, investment, and payments framework capable of supporting a multi-currency future.