Changing the world order!

If we were to look at the global monetary history over the last few centuries, the popularity of different reserve currencies have ebbed and flowed, reflecting the shifting fortunes of leading global economies. Economists argue that the demand for currencies over the long run revolves around the economic relevance and dominance of that respective country. In general, the larger and more powerful a country’s economy is, the greater the network effect, and the more interlinked they are to the global economy. Large share in global trade implies greater demand to hold that country’s currency in reserve.

In the not too distant past, the U.S. displaced the UK economically as well as the world’s reserve currency. Today, the U.S. economy is showing signs of slowing down, with other economies - especially China and India - catching up fast (Exhibit 1). Additionally, increased trade wars and sanctions by US have accentuated the search for a new trade mechanism other than US Dollar. This has only accelerated over the last year since the Russia-Ukraine conflict, thus giving wind to the De-Dollarization thesis. In this newsletter we will understand what is De-Dollarization, why is there so much interest around it and is there a possibility of it playing out?? If yes! Then how it will impact India.

Exhibit 1: US continues to be the leading economy, however China is closing the gap fast

Source: Bloomberg, Ambit Asset Management

Exhibit 2: Foreign exchange Reserves of leading global currencies

Source: COFER, International Finance Statistics, IMF Data

What is De-Dollarisation?

De-dollarisation refers to countries reducing reliance on the U.S. dollar as a reserve currency, medium of exchange or as a unit of account. It is a process of substituting US dollar as a primary currency used for:

• Trading oil and/ or other commodities (i.e. petrodollar),
• Buying US dollars for the forex reserves and 
• Bilateral trade agreements

Time line of Dollar dominance:

Exhibit 3: Japan & China are on spree to reduce their US treasury holding over last 2 years

Source: TIC Treasury Government Data 

The current situation – Why is there increased talk of De-Dollarization and how real is it?

Rising global tensions, trade wars and financial / economic sanctions have compelled countries to look for alternative form of payment / settlement other than USD. Russia is leading the de-dollarization campaign from the frontline with support from China, Iran and economies in Latin America. Russia has already offloaded $80 bn in US securities. US dollar hegemony has been a frequent target of criticism by the Chinese government in recent years, with the US-China trade war plunging bilateral relations to a decades-low point, and the ongoing tech-decoupling endeavors of the Biden administration have raised concerns of an all-out clash. The impact of US sanctions on Russia is demonstrating how much influence the US wields over a dollar-driven world, inspiring many countries to speed up their search for options.

The Sign of De–Dollarization is catching up in other parts of the world:

• Russia - Russia’s economy run on oil revenues is hit by the US-led sanctions. Russia is trying to make payments in non-dollar currencies for bilateral trade and has been transferring dollar holdings to the Russian jurisdiction. Even pre-war, the use of USD in Russia’s exports to BRICs nations crashed from ~95% in 2013 to <10% in 2020.
• China - Beijing’s de-dollarisation agenda has a parallel track in promoting own currency yuan as the alternative to the dollar in international trade and investment. The Special Drawing Rights achieved by Yuan in 2016 is a case in point. China is avoiding US dollar based transactions in bilateral trade. It has done so with Iran and agreements were signed with Canada and Qatar to that effect.
• Alternative for SWIFT? - Efforts are underway for the possible introduction of a new Russia-China payment system, bypassing SWIFT and combining the Russian SPFS (System for Transfer of Financial Messages) with the Chinese CIPS (Cross-Border Interbank Payment System).
• India - RBI has allowed International Trade Settlement in Indian Rupees (INR) to facilitate trade with partners. This initiative by RBI is aimed at facilitating the growth of global trade and to support the interests of the global trading community in INR. In FY19, India imported crude oil from Iran using Rupee based mechanism. Recently, India and Malaysia have agreed to settle trade in INR. Apart from these about 35 nations have expressed an interest in learning more about how the rupee trade mechanism works.
• Increasing talks of a BRICS currency: India, Russia and China are spearheading talks of development of a new currency which can be used for cross-border trade by these BRICS nations. On a combined GDP scale, these nations would not only outpace USA but the entire G-7, making a strong fundamental case.

Key factors in determining global reserve currency:

If, hypothetically, we were to assume that de-dollarization was to take place and other global currencies were to replace the USD in international trade, we feel that following key factors are important to determine the global reserve currency:

• Share in Global trade - One of the key reason of USD gaining prominence post WW2 and the reason it is still the leading global currency, is because of USA’s huge share in global trade (Export-Import). This makes technical and economic sense for other nations to maintain USD reserves. This will be an important consideration when searching for an alternative to the USD.

Exhibit 4: US trade share in world trade has decreased over last few decades while China and India gained share

Source: UNCTAD statistics data

• Geopolitical relations - In addition to global trade share, it is also a country’s geopolitical position / standing which determines the acceptability of their currency in international trade. China has been trying to promote the Yuan (CNY) as the alternative to USD in international trade and investment. It has been making active investments in infrastructure in Africa and Asian countries such as Pakistan and Sri Lanka, in addition to lending with an option to pay-back in CNY. These efforts would make a strong case for higher use of CNY by these countries. However, China faces stiff opposition from other developed nations owing to the lack of transparency & trust in its political and economic policy. While the CNY could become an alternative to the US dollar in a “multipolar” world but this parity with the greenback could take a few decades to play out.
• A slow and gradual process - Past data of global reserve currency suggest that the transition from one global currency to the other is often slow and subtle, usually spread over decades.  (Refer to Exhibit: 5). Talks of de-dollarization have been around for quite some time. Despite this, USD’s share in global central bank reserves is ~60% as of 2022. A compete de-dollarization may still be some (many) years away!

Exhibit 5: A Reserve Currency on an average last 96 years’ vs Current 120+ years

Source: Company, Ambit Asset Management

India's position in De - dollarized world.

• Currency for a multipolar world - It is quite likely that a ‘de-dollarized’ world may not feature a leading global currency with share as high as that of USD. There could be multiple coalition or Unions such as BRICS, Quad or the Gulf states forming a currency of their own similar to the Euro. There could also be instances of increased local-currency trade – as seen between India-Iran crude oil import. This will go a long way in curtailing India’s Current Account Deficit, securing favourable trade terms (as seen during Russia crude import in 2022) and becoming more self-reliant.
• Local borrowing - Increased acceptance of INR would make it easier for Indian government and corporates to borrow in local currency, which in turn would play a vital role in strengthening the local currency.
• Can INR become a reserve currency? - As of 2020, China constituted ~15% of global trade in spite of that China contribute merely 3% to the world’s forex reserve due to lack of trust & governance on the economic system of China. Whereas over the years - India has gained status of more trusted and stable economy due to regulatory transparency, coherence and predictability than China. So, if over next few decades India can be an economic powerhouse and gain share in global trade, the likelihood of INR being considered as a substitute to USD would certainly increase given the high trust bestowed by other nations.

Conclusion:

As Ray Dalio said “no system of government, no economic system, no currency, and no empire lasts forever, yet almost everyone is surprised and ruined when they fail.” Clearly there has been a growing trend among countries and regions like India, Brazil, and ASEAN to “de-dollarize”. Despite countries’ efforts to “de-dollarize”, replacing the U.S. dollar as the global reserve currency is a lengthy & challenging process. While overnight change may be a tall ask, the effect of countries reducing their USD dependence will become increasingly significant, eventually leading to a new global monetary and geopolitical pattern. However, the pace of change will depend on how much the system will bend before it changes the status of world reserve currency.

Exhibit 6: Ambit’s Coffee Can Portfolio point-to-point performance

Source: Ambit; Portfolio inception date is March 6, 2017; Returns as of April 30th, 2023; All returns are post fees and expenses; Returns above 1 year are annualized; Note: Returns prior to Apr’19 are returns of all the Pool accounts excluding non-aligned portfolio, and returns post Apr’19 is based on TWRR returns of all the pool accounts.

Exhibit 7: Ambit’s Coffee Can Portfolio calendar year performance

Source: Ambit; Portfolio inception date is March 6, 2017; Returns as of April 30th, 2023; All returns are post fees and expenses. Note: Returns prior to Apr’19 are returns of all the Pool accounts excluding non-aligned portfolio, and returns post Apr’19 is based on TWRR returns of all the pool accounts.

Ambit Good & Clean Midcap Portfolio               

Ambit's Good & Clean strategy provides long-only equity exposure to Indian businesses that have an impeccable track record of clean accounting, good governance, and efficient capital allocation. Ambit’s proprietary ‘forensic accounting’ framework helps weed out firms with poor quality accounts, while our proprietary ‘greatness’ framework helps identify efficient capital allocators with a holistic approach for consistent growth. Our focus has been to deliver superior risk-adjusted returns with as much focus on lower portfolio drawdown as on return generation. Some salient features of the Good & Clean strategy are as follows:  

• Process-oriented approach to investing: Typically starting at the largest 500 Indian companies, Ambit's proprietary frameworks for assessing accounting quality and efficacy of capital allocation help narrow down the investible universe to a much smaller subset. This shorter universe is then evaluated on bottom-up fundamentals to create a concentrated portfolio of no more than 20 companies at any time.
• Long-term horizon and low churn: Our holding horizons for investee companies are 3-5 years and even longer with annual churn not exceeding 15-20% in a year. The long-term orientation essentially means investing in companies that have the potential to sustainably compound earnings, with these compounding earnings acting as the primary driver of investment returns over long periods.
• Low drawdowns: The focus on clean accounting and governance, prudent capital allocation, and structural earnings compounding allow participation in long-term return generation while also ensuring low drawdowns in periods of equity market declines.

Exhibit 8: Ambit’s Good & Clean Midcap Portfolio point-to-point performance    

Source: Ambit; Portfolio inception date is March 12, 2015; Returns as of April 30th, 2023; All returns above 1 year are annualized. Returns are net of all fees and expenses

Exhibit 9: Ambit’s Good & Clean Midcap Portfolio calendar year performance

Source: Ambit; Portfolio inception date is March 12, 2015; Returns as of April 30th, 2023. Returns are net of all fees and expenses

Exhibit 12: Ambit TenX Portfolio point-to-point performance

Source: Ambit; Portfolio inception date is December 13, 2021; Returns as of April 30th, 2023; Returns are net of all fees and expenses

Exhibit 13: Ambit TenX Portfolio calendar year performance

Source: Ambit; Portfolio inception date is December 13, 2021; Returns as of April 30th, 2023. Returns are net of all fees and expenses

For any queries, please contact:

Umang Shah- Phone: +91 22 6623 3281, Email - aiapms@ambit.co | Ambit Investment Advisors Private Limited - Ambit House, 449, Senapati Bapat Marg, Lower Parel, Mumbai - 400 013

Risk Disclosure & Disclaimer

The performance of the Portfolio Manager has not been approved or recommended by SEBI nor SEBI certifies the accuracy or adequacy of the performance related information contained therein.

Ambit Investment Advisors Private Limited (“Ambit”), is a registered Portfolio Manager with Securities and Exchange Board of India vide registration number INP000005059.

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The performance data for coffee can product between 6th march 2017 - 19th June 2017 represents model portfolio returns. First client was onboarded on 20th June 2017. The performance data for G&C product between 1st June 2016 to 1st April 2018 also includes returns for funds managed for an advisory offshore client. Returns are calculated using TWRR method as prescribed under revised SEBI (Portfolio Managers) Regulations, 2020.