Page last updated at 23:41 GMT, Monday, 15 June 2009 00:41 UK

Dollar poses dilemma for Bric countries

By Katie Hunt
Business reporter, BBC News

Roubles being printed
China and Russia fear the value of their dollar holdings may fall

Brazil, Russia, India and China, collectively known as the Bric countries, are holding their first formal summit in the Russian city of Yekaterinburg.

On the agenda is the role of the dollar and its status as the world's dominant currency.

China, Russia and, to a lesser extent, Brazil have expressed a desire to see the dollar one day replaced as the world's main trading currency.

And fears that these big holders of dollar assets may be looking to switch from the US currency have unsettled financial markets and US politicians.

"Although China's call for a new reserve currency is premature, it is legitimate," says Shujie Yao, a professor of economics at the School of Contemporary Chinese Studies at the University of Nottingham.

Stir

Chinese and Russian officials have questioned the dollar's status as the dominant currency on several occasions in recent months.

Brazil has also expressed concern although India remains less active on this front.

CURRENCY RESERVES
Foreign currency held by a government or a central bank
Used to pay foreign debt obligations or influence exchange rates
The dollar is viewed as the world's reserve currency as the vast majority of reserves are held in the US currency
About 90% of all foreign exchange transactions involve the dollar

China's central bank governor caused a stir in March when he said the US dollar should be replaced as the world's largest reserve currency by the Special Drawing Right (SDR) - a unit of account issued by the International Monetary Fund.

And Russian President Dmitry Medvedev said at the beginning of this month that the idea of a "supranational currency" should be discussed at the Bric summit.

These concerns have in part led to a decline in the dollar against other major currencies in recent months and sent jitters through the market for US government debt.

'Substantial impact'

As two of the world's biggest holders of US dollar assets, China and Russia fear that the steps that the US is taking to boost its economy and help it recover from the financial crisis could undermine the value of the US currency.

BRIC COUNTRIES
Brazil, Russia, India, China
Account for more than 13% of world economy
Account for 40% of world population
Term 'Bric' coined by investment bank Goldman Sachs

"If you own trillions of dollar assets, the last thing you want is any more dollars being printed," says Simon Derrick, currency strategist at Bank of New York Mellon.

"A 10% fall in the dollar has, in theory, a substantial impact on China's spending power," he adds.

China and Russia have already taken some small steps to diversify their currency reserves away from the dollar:

  • China has made arrangements with six countries worth 650bn yuan ($95bn) that allow trade to be conducted in renminbi rather than dollars
  • China and Russia have said they will buy bonds to be issued by the IMF
  • Data released on Monday showed that both China and Russia had trimmed their holdings of US government bonds in April.

But analysts say the Bric countries are unlikely to mount a real challenge to the dollar's supremacy.

Any concrete suggestion of a wholesale switch away from the dollar would dramatically undermine the value of their own reserves.

"They are expressing their frustration but there's little they can really do about it. They can only take steps on the margin," says Jan Randolph, head of sovereign risk analysis at IHS Global Insight.

Charm offensive

These developments have not gone unnoticed in the US.

President Hu Jintao arrives in the Ural Mountains city of Yekaterinburg, Russia
China is uneasy over its vast holdings of dollars

A weaker dollar and rising government bond yields can make it more expensive for the US government to borrow money.

This ultimately could lead to problems in financing the measures taken to help the US economy recover.

To address these concerns, US Treasury Secretary Timothy Geithner visited China at the end of May to give assurance over the safety of dollar assets, and met with his Russian counterpart over the weekend at the sidelines of the G8 finance ministers meeting.

His charm offensive appears to be working, at least for now.

The dollar rose on Monday after Russian Finance Minister Alexei Kudrin said it would not be replaced as the world's reserve currency in the near future and China's vice foreign minister Ha Yafei has assured the US that "nobody is talking about dumping the US dollar".

China and Russia may now have decided that it is self-defeating to make comments that undermine the value of the dollar and thus the value of their own reserves, says Mr Derrick at Bank of New York Mellon.

But this does little to alter the basic unease Russia and China feel over their vast holdings of dollars.

"While officials may feel that it is appropriate to provide verbal support for the dollar, it will ultimately be their actions that matter," says Mr Derrick.



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