A momentous event occurred last week, the effects of which may not be felt immediately but will be felt over time: Saudi Arabia did not renew its 50-year-old petrodollar agreement with the United States.
History of the Agreement
It was 1974, the year after the Six-Day War, when Arab countries weaponized their oil resources and announced an oil embargo. To prepare for future weaponization of “black gold,” the United States and Saudi Arabia established a Joint Committee for Economic Cooperation in June 1974. The committee was empowered to facilitate Saudi Arabia’s spending in U.S. dollars. The two sides signed an agreement, and the price of oil was pegged to the U.S. dollar. This strengthened the dollar, giving it weight and dominance over all other currencies in the world, which remains the basis of the existing global economic order. Saudi Arabia also promised to invest its surplus funds in U.S. Treasury bonds in exchange for military support.
While it’s true that the deal didn’t mean the Saudis would sell their oil exclusively in dollars, the new arrangement to invest in U.S. Treasury bonds was done in secret and details only emerged later. With this deal, not only would oil be priced, but it would also be sold entirely in dollars.
This year, the agreement was not renewed. On one side, there was jubilation over the imminent demise of the dollar. On the other, there were those who dismissed the agreement as meaningless. As always, the truth lies somewhere in between.
Move towards de-dollarization
As an unintended consequence of US sanctions against Russia over the Ukraine war (including cutting Russia off from the international SWIFT system), the world is slowly but surely moving away from the dollar. To get around these sanctions, many countries, especially emerging ones, have started using local currencies for bilateral trade. India, for example, uses the Indian Rupee for trade with Russia. Last year, India bought crude oil from the UAE in INR for the first time.
But Madhu Nainan, editor of Petrowatch, warned that the yuan could be the beneficiary of the Saudi move, given the size of the Chinese economy. Over the past two years, China has emerged as not only Saudi Arabia’s largest oil importer, but also its largest trading partner.
Why the renminbi cannot be ignored
China is the world’s largest buyer of crude oil. According to data for 2022, Saudi Arabia exported $56.1 billion worth of crude oil to China. India comes in third, importing $32.7 billion of Saudi Arabian crude oil. At the same time, the total trade volume between China and Saudi Arabia was $106 billion. Of this, Chinese exports to Saudi Arabia accounted for $36.5 billion, which is expected to increase.
Amid the escalating U.S.-China conflict, China has been promoting the use of the yuan in foreign trade, including with Saudi Arabia. China and Saudi Arabia signed a local currency swap agreement worth $7 billion in 2023 as part of efforts to boost trade using their respective currencies and reduce reliance on the dollar.
Saudi Arabia this year signed up to the mBridge project, launched in 2021, between the central banks of China, Hong Kong, Thailand and the UAE to develop a new system for cross-border payments using central bank digital currencies.
A China-brokered ceasefire between Iran and Saudi Arabia last year further expanded China’s influence in the region, and Saudi Arabia has expressed interest in joining the UAE and four other countries in the BRICS group of nations, which are discussing alternative trading currencies and many of which have begun trading in their own currencies.
Therefore, while Saudi Arabia’s decision does not eliminate the important role of the US dollar, it will certainly contribute to the ongoing de-dollarization process in international trade.
An opportunity for the Indian rupee?
What does all this mean for India? India has ambitions to popularize the Indian rupee internationally. It already trades in rupees with Russia. More recently, it signed a local currency trade agreement with the UAE and made its first oil purchase in rupees. India is in talks with Singapore about local currency settlements, which could be extended to the ASEAN bloc in the future.
India is also currently working to diversify its foreign exchange reserves, which as of May 3 stood at about $641 billion, most of which is held in U.S. dollars, according to Reserve Bank of India (RBI) data.
“Our priority is to diversify our foreign reserve allocation into more currencies and different types of assets, especially gold,” Reserve Bank of India Governor Shaktikanta Das said at a recent event. But it remains to be seen how the expiration of the petrodollar pact will affect India. India’s trade volume with Saudi Arabia is nowhere near that of China.
According to 2023 data, bilateral trade between India and Saudi Arabia has grown, with total turnover reaching $52.76 billion. India’s imports from Saudi Arabia were $42.03 billion and exports were $10.72 billion during the period. With the trade balance heavily tilted towards Saudi Arabia, it is doubtful whether India will be able to strike a deal to pay for Saudi crude oil in Indian rupees.
For now, the possibilities are limited
To put it in perspective, India pays for Russian crude oil in Indian rupees, but billions of rupees have piled up in Indian banks that Russia has no way of spending, creating a growing problem. But if India can accelerate its manufacturing base and increase exports, a deal may be possible.
The collapse of the Petrodollar Agreement will not affect the price of oil on the global market, since it is linked to supply and demand. Furthermore, Saudi Arabia’s currency, the riyal, remains pegged to the US dollar. Also, both the US and Saudi Arabia are reportedly negotiating a new security pact that will once again strengthen the central role of the dollar.
At the same time, Saudi Arabia, like many other countries, is seeking to diversify its foreign exchange reserves and reduce its reliance on the US dollar. Thus, while the US dollar will continue to dominate for the time being, the world is undoubtedly moving towards alternative currencies. The expiration of the petrodollar trade will be a catalyst for this de-dollarization process.
(Aditi Bhaduri is a journalist and political analyst)
Disclaimer: These are the personal opinions of the author.
