De-dollarisation & Gateway to Rupee Fixation

Syllabus: GS3/ Indian Economy & Related Issues

In Context

• The de-dollarisation phenomenon can be complemented with the internationalisation of the INR. 

What is de-dollarisation?

• De-dollarisation is a term that refers to the process whereby countries tend to reduce their reliance on the US dollar as a reserve currency, medium of exchange, and also a unit of account. 

Significance of De-dollarisation

• Countries seek to reduce their overreliance on the US dollar and enhance their economic sovereignty by diversifying their currency reserves and conducting transactions in alternative currencies. 
• Reducing reliance on the US dollar enables countries to 
  • Develop their financial systems, 
  • Pursue economic policies aligned with their national interests, and 
  • Strengthen their financial objectives. 
• Nations that are at odds with the US or face geopolitical pressures may seek to minimize their exposure to the dollar, reducing their vulnerability to potential sanctions or economic pressures. 
• This shift towards a multipolar global financial system, where no single currency dominates, may lead to increased financial inclusivity and reduced vulnerabilities associated with currency fluctuations.

Reasons Behind De-dollarisation

• Risks of over-dependence on a single currency:
  • The over-dependence on a single currency exposes the nation to risks associated with fluctuations in the value of the dollar, changes in US monetary policy, and potential sanctions or restrictions imposed by the US. 
  • The US government has been running large budget deficits for years, and this has led to concerns about inflation and the value of the dollar.
• US’s geopolitical conflicts:
  • The US has been involved in several geopolitical conflicts in recent years, including the wars in Iraq and Afghanistan. 
  • These conflicts have led to increased tensions between the US and other countries, which has made some countries less willing to use the dollar.
• China factor:
  • China is the world’s second-largest economy and is becoming increasingly influential in global trade. 
  • China has been promoting the use of its currency, the renminbi, as an alternative to the dollar.
• Rise of Cryptocurrencies:
  • Cryptocurrencies, such as Bitcoin, are a new form of digital currency that is not subject to government control. 
  • This has made them attractive to people who are looking for an alternative to the dollar.

Challenges of De-dollarisation

• Confidence building: One of the biggest challenges is the potential for devaluation or loss of trust in the new currency. 
  • If the new currency is not seen as being as stable or as liquid as the dollar, it could lead to economic instability and hinder financial transactions. 
  • It is therefore important to build confidence and trust in the new currency before making the switch. 
• Complicating international transactions: Many commodities, such as gold and oil, are priced and traded in dollars. This means that shifting away from the dollar could complicate international transactions and make it more difficult to trade these commodities. 
  • This could also hamper foreign direct investment and capital flows. 
• Countries with significant debt in USD: Countries with significant debt in USD will also face special challenges when trying to reduce their reliance on the dollar. 
  • If they suddenly move away from the dollar, their debt could become more expensive because their currency may lose value or exchange rates may fluctuate. 
  • This could lead to financial instability and make it more difficult to repay the debt.
• Increased volatility during the transition period: De-dollarisation could lead to increased volatility in currency exchange rates during the transition period. 
  • Countries with less developed financial markets or limited policy tools may face greater challenges in managing exchange rate volatility. 
• Absence of a clear alternative to the US dollar: The Euro, Japanese Yen, and British Pound are potential contenders, but they are closely linked to the US economically and politically. 
  • Other currencies, like the Chinese Yuan, face obstacles such as capital controls and limited convertibility. 
  • Attempts at de-dollarisation through initiatives like BRICS (Brazil, Russia, India, China, and South Africa) face significant challenges. These countries have diverse cultures, politics, and economies, making consensus on a common currency and monetary policy difficult to achieve. 
  • A lack of cooperation among member countries could further hinder progress. 

Potential of Rupeefication

• In India, while a complete overhaul of the trade invoicing system is not feasible, de-dollarisation can be complemented with internationalisation of the INR—rupeefication. 
• Rupeefication will require 
  • Complete freedom over buying or selling of the INR by any entity, 
  • The ability of the country’s exporters to invoice their trade in INR, and 
  • Holding as well as issuing of the INR and financial instruments denominated in it by foreign entities.

Advantages of Rupeefication for India

• Rupeefication will entail advantages both for the private and public sectors. 
• Exporters can benefit at large by limiting exchange rate risk and deepen their markets as the INR becomes more widely accepted. 
• With greater access to international financial markets and reduced cost of borrowing, profitability can be increased in the private sector, which will also encompass the non-financial sector. 
• The public sector will be able to finance its deficit by issuing international debt denominated in INR and have the option to finance its current account deficit without depleting its official US dollar reserves. 

Way Ahead

• While the US economy may be facing challenges and its supremacy may be weakening, it still maintains a strong position with credibility in the financial markets.
• As long as the US continues to provide stability, credibility, and attractive opportunities compared to other options, the world will likely continue to rely on the US dollar. However, if a viable alternative currency emerges that offers similar advantages, the breaking point for the US dollar and its dominance could occur.
• While de-dollarisation is only a tool in India’s arsenal, the focus should be on gradual and consistent rupee fication to establish itself as a global leader.