Potential Risks of US Dollar Dominance in the ASEAN+3 Financial System

The dominance of the US dollar in the ASEAN+3 financial system poses stability risks. Policymakers could bolster resilience by promoting economic stability, monitoring USD activity, implementing macroprudential safeguards, and diversifying with regional currencies.

Dominance of the US Dollar in ASEAN+3 Financial Systems

The US dollar plays a significant role in the ASEAN+3 region’s economic activities, particularly in cross-border banking, foreign exchange reserves, and currency trading. Around 80 percent of trade invoices in ASEAN+3 are denominated in US dollars, and more than half of the banks’ cross-border assets and liabilities are in the same currency. The dominance of the US dollar is evident as nearly 85 percent of currency trading in the region is against the dollar, with Asia Pacific central banks allocating 68 percent of their reserves to US dollar assets. Despite a decline in ASEAN+3’s direct trade and investment connections to the US over the past decade, the US dollar continues to maintain its prominence across various sectors, including external financing.

Financial Risks and Market Responses

ASEAN+3’s dependence on the US dollar introduces financial stability risks, such as heightened susceptibility to US dollar funding stress and its role as a transmission channel for global shocks. This vulnerability mainly emerges when market volatility and currency depreciation expectations rise, leading to increased borrowing costs and restricted access to funding. Consequently, non-financial companies face USD liquidity risks due to reduced hedging and credit line drawdowns. Despite recent challenges, the region has shown resilience against US dollar funding stress, primarily attributed to strong external positions and supportive micro-market factors like increased USD deposits from domestic investors. The stabilization of the US funding landscape following the March 2023 regional banking crisis, along with potential Fed rate cuts, could further improve USD liquidity conditions.

Enhancing Resilience and Reducing Dollar Reliance

To bolster resilience, ASEAN+3 policymakers are encouraged to strengthen regional cooperation, improve surveillance of US dollar liquidity, and implement robust macroprudential regulations. These measures are essential in addressing short-term external shocks transmitted through the US dollar. Over the long term, reducing reliance on the US dollar by diversifying currencies used in regional trade and financial transactions is crucial. Encouraging the use of local currencies, supported by coordinated regulations and technology, could enhance financial stability and make regional currencies more attractive for cross-border activities. By focusing on economic stability and embracing strategic diversification, ASEAN+3 economies can foster a more balanced currency ecosystem and reduce the risks associated with the US dollar’s dominance.

Source: Risks of US Dollar’s Dominance on ASEAN+3 Financial System