The state of de-dollarisation in the Gulf region

The states of the Gulf Cooperation Council, partly in response to the United States’ unprecedented recourse to financial sanctions against Russia, are taking steps to broaden their ability to transact within both dollarised and de-dollarised zones of the global economy. While these states remain firmly embedded in the US-led economic and security architecture, they still see some advantages in reducing their reliance on the US and its currency.

In March 2023, China completed its first-ever purchase of liquified natural gas from the United Arab Emirates using its own currency, the yuan, on the Shanghai Petroleum and Natural Gas Exchange. This fuelled speculation that the hydrocarbon-exporting states of the Gulf Cooperation Council (GCC) were on course to de-dollarise oil and gas sales. While Iran has long sought to de-dollarise energy transactions to circumvent financial sanctions imposed by the United States, the GCC states, whose strategic partnership with the US dates to the 1970s, have traditionally backed the international dollar-based system.

The GCC states are now changing perspective and view the US’s unprecedented recourse to export controls, financial sanctions and oil-price caps against Russia as setting dangerous examples that threaten to unravel the international economic order. As a result, they are taking steps to reduce reliance on the US dollar, exploring alternative arrangements involving China, India and other regional trading partners. In the absence of a credible alternative, however, the Gulf states are unlikely to abandon the dollar altogether. Rather, they are seeking to limit their reliance on the US and its currency by increasing the options available to them.

Dependency fears

Since the early 1970s, the Gulf Arab states’ relations with the US have been underpinned by an oil-for-security arrangement that has allowed these oil-exporting nations to enrich themselves while supporting the US dollar’s position as the world’s main reserve and trading currency. The arrangement, often referred to as ‘petrodollar interdependence’, dates to June 1974 when US president Richard Nixon and King Faisal bin Abdulaziz Al Saud of Saudi Arabia concluded an agreement whereby Riyadh would guarantee the free flow of oil – priced in dollars – in return for US protection and weapons sales. Moreover, Saudi Arabia pegged its currency to the dollar in 1986 and recycled its large oil revenues into US treasury bonds, thereby tying its own economic interests to the dollar.

The US–Saudi partnership has, however, come under immense pressure since 2021 due to differences over energy policy. The decision by the administration of US President Joe Biden to orchestrate the largest-ever depletion of the US Strategic Petroleum Reserve in 2022 to lower oil prices may have cost Saudi Arabia up to US$100 billion in lost revenues, according to some estimates. When OPEC+, led by Saudi Arabia, slashed oil-production quotas in October 2022 to raise prices, one month ahead of the US midterm elections, Washington vowed to impose ‘consequences’ on Riyadh, demonstrating the extent to which energy policy had become a contentious issue for US–Saudi relations.

US measures to ease oil prices and target Russia’s oil interests, moreover, have been interpreted in Riyadh as an attempt to rewrite the rules of the global oil market. The Saudis worry that the G7’s price cap on Russian oil exports, if successful, could be scaled up by oil consumers to set the market price for oil. By gaining the ability to control prices, oil consumers would be in a position to threaten OPEC’s, and by extension Saudi Arabia’s, traditionally pre-eminent positions in the global oil market. Riyadh also worries that the US could in the future wield price caps to punish other oil producers. The Saudi Minister of Energy Prince Abdulaziz bin Salman Al Saud warned in March 2023 that ‘if a price cap were to be imposed on Saudi oil exports, we will not sell oil to any country that imposes a price cap on our supply, and we will reduce oil production’. Moreover, Riyadh opposes legislative efforts within the US Senate to target OPEC under the No Oil Producing and Exporting Cartels Act. Abdulaziz has described the legislation as adding ‘new layers of risk and uncertainty’, claiming that OPEC+ has ‘succeeded in bringing stability and transparency to the oil market’.

Against the backdrop of worsening US–Saudi relations, the Saudis are concerned that Washington’s no-holds-barred approach to targeting Russia’s economy could end up threatening any country, including their own, that relies on the US-led international financial system.

Against the backdrop of worsening US–Saudi relations, the Saudis are concerned that Washington’s no-holds-barred approach to targeting Russia’s economy could end up threatening any country, including their own, that relies on the US-led international financial system. The US has frozen approximately US$300bn of Russia’s dollar reserves and imposed countless export controls and extraterritorial sanctions targeting Russian entities and individuals. Saudi Arabia is arguably even more vulnerable to US economic coercion should relations with Washington sour; after all, Riyadh holds hundreds of billions of dollars in reserves and sovereign investments (see Figures 1 and 2), prices its main export commodity in dollars and pegs its own currency to the dollar.

China’s de-dollarisation push in the Gulf

At the same time, China has pushed the GCC states to de-dollarise oil and gas sales. At the China–GCC summit held in Riyadh in December 2022, China’s President Xi Jinping announced that China will work to expand its oil and gas trade with the Arab countries and to use the Shanghai Petroleum and Natural Gas Exchange to settle transactions in yuan. China has also proposed the extension of its Cross-Border Interbank Payment System to the GCC region as an alternative platform to SWIFT.

Saudi officials have appeared responsive to China’s overtures and have not ruled out the possibility of Riyadh settling oil trade in currencies other than the dollar. Saudi Minister of Finance Mohammed Al-Jadaan, speaking at Davos 2023, stated ‘there are no issues with discussing how we settle our trade arrangements, whether it is in the US dollar, whether it is the euro, whether it is the Saudi riyal’. With encouragement from China, Saudi Arabia formally requested to join the BRICS bloc in early 2023. Some analysts have argued that the grouping, which has emerged as a significant geo-economic bloc within the Global South and does not include any of the G7 member states, could serve as a vehicle for undermining the dollar’s global pre-eminence. Saudi Arabia is also considering joining the New Development Bank, a multilateral lender set up by BRICS in 2014 as an alternative to the IMF and World Bank.

Barriers to GCC de-dollarisation

The Gulf states would have to surmount several obstacles in any attempt to comprehensively de-dollarise. The absence of a credible alternative is the main economic barrier. The yuan would be a poor replacement due to capital controls that restrict the transfer of funds in and out of China. Despite Beijing’s effort to internationalise its currency, the yuan still accounts for only about 4.5% of global trade transactions. China has also historically depressed the yuan’s value to improve its export competitiveness, which means that future devaluations could wipe out the value of investors’ yuan holdings. By accepting yuan, moreover, the Gulf states would set a precedent that could encourage other key importers of Gulf oil, such as Japan or India, to demand similar terms. Iran and Russia have had difficult experiences settling trade with India in rupees, for instance, highlighting the potential unattractiveness of such arrangements. Dubbed by some as the ‘rupee trap’, Tehran and Moscow have accumulated large sums of rupee holdings in Indian bank accounts that they have not been able to exploit due to a lack of demand for Indian products. Finally, since GCC currencies – with the exception of Kuwait’s dinar – are pegged to the dollar, the GCC states have a strong incentive to continue accumulating dollar reserves to maintain their currency pegs.

Despite Beijing’s effort to internationalise its currency, the yuan still accounts for only about 4.5% of global trade transactions.

A decisive pivot away from the US dollar could undermine the decades-long oil-for-security partnership that GCC states share with the US. Politically, the states retain close relations with Washington given that it is still their main defence and security partner. In November 2022, the UAE called upon the US to formalise its security commitment to the region, implying an enduring appetite among the GCC states for a strong defence relationship with Washington.

Other Gulf states

Iran, having spent decades under US and international sanctions, is an expert in the de-dollarisation of trade. It set up a rupee mechanism with India to insulate trade from US and European Union sanctions imposed in 2012, in effect exporting Iranian oil in return for Indian agricultural products. It also used Turkiye as a centre for obtaining payments for oil and gas exports in euros and gold. Iran’s sanctions-busting arrangements routinely collapsed, however, as the US lifted waivers on Indian imports of Iranian oil in 2019. The US has also indicted Halkbank, a major Turkish state-owned bank allegedly involved in facilitating payments for Tehran, for undermining US sanctions against Iran. Even without Iran’s relying on the dollar, US pressure on Tehran’s trading partners has forced it to continuously reconfigure its trading arrangements.

Seeking to build on the recent political momentum behind de-dollarisation in the context of Russia’s war against Ukraine, Iran has attempted to devise alternative financial arrangements among the growing club of economies sanctioned by the US. In May 2023, Iran hosted the 51st meeting of the Asian Clearing Union with the aim of accelerating de-dollarisation, calling it an ‘inevitable response’ to the US’s weaponisation of the dollar. Moreover, Iran claims that it abandoned dollar trade with Russia in July 2022. Both countries are also reportedly considering a new gold-backed cryptocurrency or ‘stablecoin’ and exploring means of linking their banking systems to settle transactions.

Iraq, by contrast, suffers from a different kind of de-dollarisation problem. Due to a lack of public confidence in government institutions, it has struggled to promote the use of its own currency, the Iraqi dinar, within its local economy. On 14 May 2023, Baghdad outlawed the use of US dollars to settle local transactions in an attempt to encourage greater use of the dinar. To stem the shortage of dollars, the Iraqi Central Bank announced in February 2023 that it would allow domestic banks to settle cross-border trade with China in yuan. The move also reflects the fact that China is a major economic player in Iraq. Chinese national oil companies own stakes in oilfields that collectively account for about half of Iraq’s oil production and purchase about a third of Iraq’s total oil exports, according to the Observatory of Economic Complexity.

Outlook

Although the GCC states are unlikely to ditch the US dollar soon, they are nevertheless developing a broader financial toolkit to mitigate their dependency. Saudi Arabia and the UAE are experimenting with central-bank digital currencies, for instance. In 2019, the Saudi and Emirati central banks launched project Aber to experiment with the use of a single, dual-issued digital currency to settle transactions between commercial banks across their jurisdictions. Three years later, the UAE participated in mBridge, a pilot project led by the Bank for International Settlements involving central and commercial banks from China, Hong Kong, Thailand and the UAE, to explore the settlement of cross-border transactions in multiple central-bank digital currencies on a single platform. Despite being in their early stages, central-bank digital currencies appear to be a potentially promising new tool for reducing dollar dependency for regional and trans-regional cross-border exchanges. These initiatives will likely become more common and widespread in the Gulf.

Although the GCC states are unlikely to ditch the US dollar soon, they are nevertheless developing a broader financial toolkit to mitigate their dependency.

Despite the GCC states’ receptivity to China’s overtures and intractable differences with the US on some issues, the economic and political barriers to de-dollarisation in the Gulf remain significant. The GCC states are too firmly embedded in the US-led economic and security architecture to forego the dollar, and there are no credible indicators – such as the abandonment of their currency pegs or an end to their defence partnerships with the US – to suggest otherwise. Changes in these areas could presage a shift. Ultimately, the long-term strategy of the Gulf states is to develop the ability to transact within both dollarised and de-dollarised zones, not to lead the charge against the US-led international economic order.

[Salon] The state of de-dollarisation in the Gulf region

The state of de-dollarisation in the Gulf region

Dependency fears

China’s de-dollarisation push in the Gulf

Barriers to GCC de-dollarisation

Other Gulf states

Outlook