India is wary of over-dependence on the dollar, and the RBI is hedging against dollar reliance but not pushing for de-dollarization. What do dollarization and de-dollarization mean?
A key reason India is not supporting de-dollarization is the rise of the Chinese yuan as a potential competitor to the US dollar. India has refrained from using the yuan for imports of Russian oil, despite the increasing acceptance of this currency in Russia.
However, India is cautious about becoming overly dependent on the dollar. The RBI has ramped up its gold purchases and has started repatriating gold that was previously held overseas back into the country.
Why in News?
Reserve Bank of India (RBI) former Governor Shaktikanta Das stated on December 6, that India is not pursuing “de-dollarisation.” He explained that the recent measures aimed at promoting transactions in domestic currencies are designed to mitigate risks in Indian trade.
The clarification came days after US President-elect Donald Trump threatened “100 percent tariffs” against BRICS countries if they attempted to decrease reliance on the US dollar in international trade.
Dollarization
Dollarization is the process by which a country decides to recognize the U.S. dollar (stronger currency) as a medium of exchange alongside or in place of its domestic currency. It is a form of currency substitution where governments may choose to partially or fully adopt a foreign currency.
For the past 80 years, the US dollar has been the dominant global reserve currency. Central banks, corporations, and travelers rely on the dollar to facilitate international trade and financial transactions. Today, the dollar is the most widely held reserve currency, playing a role in an estimated $6.6 trillion in daily transactions. Its supremacy underpins the global financial system.
Notably, the history of the beginning of ‘Dollarization‘ goes back to the Bretton Woods Conference of 1944, which redefined the global monetary order with participation from 44 Allied countries, including the US, Canada, and much of Western Europe.
In response to Europe’s need for financial stability post- second world war, the US established the dollar as the central reserve currency, pegging global currencies to it and making it convertible to gold at a fixed rate. This framework fostered stability in international trade and solidified the dollar’s dominance in the global economy. Under the Bretton Woods system, the dollar’s centrality was reinforced by its role in international transactions and trade.
The global dominance of the U.S. dollar can be observed in several ways, including:
(i) Central banks hold reserves of various currencies to settle international claims, intervene in foreign exchange markets, or maintain emergency funds. In this context, the share of U.S. dollar reserves is typically the highest.
(ii) The dollar is dominant for transactions between non-U.S. exporters and importers.
(iii) Commodities such as oil and gold are typically denominated in U.S. dollars, as are benchmark futures such as Brent.
(iv) Gulf oil producers peg their currencies to the dollar to avoid risk from fluctuations when invoicing their sales.
(v) The dollar’s supremacy was highlighted in 2018 when Washington decided to reimpose sanctions on Iran and all those doing business with it – any country breaking sanctions risked having access to dollars cut off.
What is global reserve currency?
A reserve currency is defined as “a foreign currency that a central bank or treasury holds as part of its country’s formal foreign exchange reserves.” Countries hold reserves for a number of reasons including to withstand economic shocks, pay for imports, service debts and regulate the value of their own currencies.
The International Monetary Fund (IMF) recognises eight reserve currencies, namely the Australian dollar, the British pound sterling, the Canadian dollar, the Chinese renminbi, the euro, the Japanese yen, the Swiss franc, and the US dollar, but the US dollar is considered to be the global reserve currency as it is most commonly held, accounting for 59 per cent of global foreign exchange reserves.
De-dollarization
De-dollarization, in simple terms, is the process of reducing dependence on the dollar. Discussions about ‘de-dollarization’ have gained momentum in recent decades. This trend is driven by U.S. sanctions and a growing shift toward multipolarity.
Countries such as China and Russia are increasingly using the Chinese renminbi (RMB) for trade. The BRICS bloc is also exploring the possibility of creating a new common currency to reduce their dependence on the U.S. dollar.
In this context, US President-elect Donald Trump has criticized a potential rival currency from BRICS nations, threatening steep tariffs. His stance underscores a serious concern about the dollar’s role as the primary reserve currency, which provides the U.S. with significant economic and political power—a privilege it is unlikely to give up easily.
Rise in use of Non-Traditional Reserve Currencies
The IMF’s Currency Composition of Official Foreign Exchange Reserves (COFER) has pointed to a gradual decline in the US dollar’s share of central bank and government foreign reserves. However, this decrease in the dollar’s dominance over the past two decades has not been accompanied by significant increases in the shares of other major currencies, such as the euro, yen, and pound, according to the IMF.
“Rather, this has been accompanied by a rise in the share of what we refer to as non-traditional reserve currencies, including the Australian dollar, Canadian dollar, Chinese renminbi, South Korean won, Singaporean dollar, and the Nordic currencies,” the IMF said in July.
Notably, the IMF said that among the non-traditional reserve currencies, the Chinese renminbi is gaining significant market share, with its growth offsetting a quarter of the decline in the dollar’s dominance.
Internationalization of Rupee
Since the United States removed Iran and Russia from the Society for Worldwide Interbank Financial Telecommunication (SWIFT), which is essential for international financial transactions, countries around the world, including India, have sought to reduce their dependence on the US dollar and the US-led global financial system.
In 2022, the RBI initiated an effort to reduce dependence on the US dollar and internationalize the rupee by allowing invoicing and payments for global trade in rupees. This decision followed the imposition of sanctions on Russia amid the Ukraine war.
Internationalization of the Rupee aims to promote the Indian rupee as a global currency in trade, increasing its international acceptance and usage.