DE-DOLLARIZATION

DE-DOLLARIZATION  I   RACE IAS : BEST IAS coaching in lucknow I  Current Affairs

Main Examination: General Studies-2 & 3

(Indian Governance and Economy)

Why in News?

  • Recently, India and Malaysia have agreed to settle trade in Indian Rupee.

About De-Dollarization:

  • De-dollarization is a process of replacing the US dollar with some other agreed currency for conducting international trade transactions. It is a way of reducing the dominance of the dollar in global markets.
  • It is a process of replacing the US dollar as the currency which is also used in the following ways:
  • Commercial oil and/or other commodities
  • Buying US dollars for foreign exchange reserves
  • Bilateral trade agreements
  • Dollar denominated assets
  • The influential role of the dollar in the global economy establishes US dominance over other economies. The US has long used sanctions as a means to achieve its foreign policy goals.
  • De-dollarization seeks to insulate the central banks of various countries from risks.

About Dollarization:

  • Dollarization is a form of currency substitution, where the dollar is used in addition to or in place of a country's local currency.
  • Although many economies are largely dollarized, only tax haven countries such as Liberia and Panama can be defined as truly 'dollarized'.
  • In fact two-thirds of the dollar is kept outside the United States that issues it.
  • Countries such as Bolivia that have suffered from hyperinflation have also been dollarized, with more than 80% of the currency being used in dollars.

Advantages of De-Dollarization:

  • Reduced dependence on the US dollar:By using other currencies or a basket of currencies, countries can reduce their dependence on the US dollar and the US economy, which can help reduce the impact of economic and political changes in the US .
  • Improving economic stability:By diversifying their reserves, countries can reduce their exposure to currency fluctuations and interest rate changes,which can help improve economic stability and reduce the risk of financial crisis.
  • Increase trade and investment: By using other currencies, countries can increase trade and investment with other countries that may not have strong ties to the US, which can open up new markets and opportunities for growth.
  • Direct trading in the country's national currency saves on currency conversion spreads.
  • Reducing US monetary policy impact: By reducing the use of the US dollar, countries can reduce the impact of US monetary policy on their economies.

Challenges :

  • Not fully convertible:The challenge for national currencies is that they are not fully convertible. Thus, despite the rise of alternative systems of trade and multiple currency circulation systems, the dollar still dominates.
  • Currency fluctuations:National currencies can fluctuate in value relative to the dollar, making it difficult for countries to plan their economic policies and for businesses to make long-term investments.
  • Limited use of national currencies in international trade:The dollar is widely used in international trade, making it difficult for national currencies to compete. This can make it difficult for countries to trade with each other and for businesses to expand internationally.
  • Dependence on the Dollar:Many countries rely heavily on the dollar for trade and financial transactions, which can make them vulnerable to changes in the dollar's value and US government policies.
  • Financial instability:The dominance of the dollar in the international financial system can contribute to financial instability in other countries, as they may be more vulnerable to financial crises.
  • Monetary sovereignty: The hegemonic role of the dollar limits the monetary sovereignty of other countries by making it difficult for them to use monetary policy to stabilize their economies.

Current Rupee Payment System:

  • At present, India always transacts exports or imports from countries other than countries like Nepal and Bhutan in a foreign currency only.
  • At present, in case of imports to India, foreign companies have to pay in foreign currency only. India has to maintain sufficient foreign exchange reserves to make payments to foreign companies.
  • This foreign exchange reserve is received by Indian companies from the export of goods in the form of foreign currency like dollar, euro, pound, yen etc.

Major Initiatives of Government of India:

  • The Reserve Bank of India unveiled a rupee settlement system for international trade as a step towards internationalization of the rupee.
  • Banks in 18 countries have been permitted by the Reserve Bank of India (RBI) to open Special Rupee Vostro Accounts (SRVA) to settle payments in Indian Rupees.
  • India and Russia are considering the use of a third currency or involving a third country such as the United Arab Emirates to facilitate oil trade between the two countries.

Way forward:

  • Indian economy is growing rapidly. Along with this, the strength of the Indian rupee is also increasing.
  • According to noted economist NourielRoubini, the Indian rupee may become the new dollar in the near future through de-dollarization.
  • But this can be possible only if India exports more and more internationally and strengthens financial markets to manage capital account convertibility, large scale capital inflows and outflows.

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Mains Exam Question:

Recently, India and Malaysia have agreed to settle trade in Indian Rupee. In this context, analyze India's foreign exchange payment system.