Geopolitical Proximity and the Use of Global Currencies

IMF Working Papers, September 6, 2024

Source details

After decades of increasing global economic integration, the world faces a growing risk of geoeconomic fragmentation with potentially far-reaching implications for the global economy and the international monetary system.
This paper studies how geopolitical proximity, along with other economic factors, affects the usage of five SDR currencies in cross-border transactions.
Since World War II, the global currency landscape has remained relatively stable, with the U.S. dollar serving as the dominant currency.
Using country-level SWIFT transaction data, the analysis confirms the importance of inertia, trade and financial linkages in shaping the currency landscape.
Closer geopolitical proximity can boost the use of the euro and renminbi, notably among emerging market and developing economies, although the impact is rather muted in the full sample.
The effect on RMB usage in the full sample is more pronounced during periods of heightened trade policy uncertainty.
These findings suggest that in a more geoeconomically fragmented world, alternative currencies could play a greater role.

Currency dominance since World War II:
- The U.S. dollar remains the dominant global currency.
Determinants of currency usage identified:
- Inertia (past usage patterns) is an important determinant.
- Trade linkages shape currency choice.
- Financial linkages shape currency choice.
Geopolitical proximity effects:
- Closer geopolitical proximity is associated with increased use of the euro and renminbi.
- The increase is notable among emerging market and developing economies.
- In the full sample, the effect of geopolitical proximity is rather muted.
- For the renminbi (RMB), the usage effect in the full sample is stronger during periods of heightened trade policy uncertainty.

Data source:
- Country-level SWIFT transaction data are used to analyze currency usage in cross-border transactions.
Currencies analyzed:
- Five SDR currencies (implicitly the SDR basket) are examined for usage patterns.

Geoeconomic fragmentation risk:
- A shift toward greater geoeconomic fragmentation could alter the international monetary system and cross-border currency usage patterns.
Role of alternative currencies:
- The euro and renminbi could play a greater role in cross-border transactions if geopolitical alignment strengthens or fragmentation increases.
Interaction with trade policy uncertainty:
- Heightened trade policy uncertainty amplifies the effect of geopolitical proximity on RMB usage in the full sample, suggesting that policy uncertainty can accelerate currency shifts linked to geopolitical alignment.