In recent news, the Reserve Bank of India (RBI) informed a parliamentary panel about the potential impact of cryptocurrencies on India’s economy, raising concerns of ‘dollarisation’. Dollarisation, in simple terms, is a phenomenon where dollars are used in addition to or as an alternative to the local currency of a country.
Understanding Dollarisation
Dollarisation is more prevalent among tax havens such as Liberia and Panama. Interestingly, two-thirds of dollars are held outside the United States, the country of issue. Countries suffering from hyperinflation also fall victim to dollarisation, an example being Bolivia with over 80% of the currency in use being dollars.
De-dollarisation Defined
Counteracting dollarisation is de-dollarisation, a process aimed at reducing the dollar’s dominance of global markets. This process involves substituting US dollar as the primary currency used for trading oil and other commodities, buying USD for forex reserves, bilateral trade agreements, and dollar-denominated assets.
US Influence through Dollarisation
The dominant role of the dollar in the global economy provides the US with disproportionate influence over other economies. The US has often used the imposition of sanctions as a strategic tool to achieve foreign policy goals. De-dollarisation is driven by the desire to insulate central banks of countries from geopolitical risks, where the US dollar’s status as a reserve currency can be weaponised.
Impact of Dollarisation on India’s Economy
Despite its current inflation woes, India is far from extensive dollarisation. However, research indicates that Indian EXIM transactions are predominantly dollar-based. A staggering 86% of both Indian imports and exports are invoiced in dollars, even though only 5% of India’s imports and 15% of exports are from and to the US. This highlights that few countries use their own currencies for international transactions because of the dollar’s wide acceptance.
Concerns related to Dollarisation
High dollarisation presents challenges to a country’s financial stability. Central banks in highly dollarised economies can become powerless, with cryptocurrencies replacing traditional currency in domestic and cross-border transactions. This threat potential is why RBI opposes cryptocurrencies, backed by the Indian finance ministry imposing a 30% crypto tax.
Cryptocurrency and its Threats
Cryptocurrencies are not only used for illicit activities such as terror financing, money laundering and drug trafficking, but they also pose a significant threat to a country’s financial system’s stability. Also, they have a negative impact on the banking system as they draw away people’s savings, resulting in banks having lesser resources to lend.
The Path Forward
At present, the US dollar continues to be the preferred choice for trade owing to its liquidity. Diversifying the currency market seems to be the only viable path forward. The world is not seeking a mere change in regime but a future where no single currency claims hegemony.