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Indian Economy

Dollarisation Due to Cryptocurrencies

  • 16 May 2022
  • 5 min read

For Prelims: RBI, Dollarisation and De-dollarisation, cryptocurrencies, forex reserves

For Mains: Dollarisation Due to Cryptocurrencies, Effect of Policies & Politics of Countries on India's Interests

Why in News?

Recently, Reserve Bank of India (RBI) told a parliamentary panel that cryptocurrencies can lead to "dollarisation" of a part of the economy which would be against India's sovereign interest.

What is Dollarisation?

  • Dollarisation is a form of currency substitution, where dollars are used in addition to or instead of the local currency of a country.
    • Though only tax havens like Liberia and Panama can be defined as ‘dollarized’ in a true sense, there are many economies dollarised to a large extent.
  • In fact, two-thirds of dollars are held outside the United States which issues it.
    • Countries which have been victims of hyperinflation like Bolivia have become dollarised too, with over 80% of the currency in use being dollars.

What is De-dollarisation?

  • It refers to reducing the dollar’s dominance of global markets. It is a process of substituting US dollar as the currency used for:
    • Trading oil and/ or other commodities
    • Buying US dollars for the forex reserves
    • Bilateral trade agreements
    • Dollar-denominated assets
  • The dominant role of the dollar in the global economy provides the US a disproportionate amount of influence over other economies. The US has for long used imposition of sanctions as a tool to achieve foreign policy goals.
    • The de-dollarisation is driven by the desire to insulate the Central Banks of the Countries from geopolitical risks, where the status of the US dollar as a reserve currency can be used as an offensive weapon.

How Dollarisation Affects an Economy?

  • In spite of its current inflation troubles, India is far away from dollarisation to this extent.
    • However, according to some research papers, Indian EXIM transactions are dominated by dollars.
  • 86% of both Indian imports and exports are invoiced in dollars.
  • Only 5% of India’s imports and 15% of exports are from and to the US.
    • It shows that few countries use their own currencies for international transactions due to the popularity of the dollar abroad.

What are the Related Concerns?

  • Challenges to the Stability of the Financial System:
    • Central banks of economies with high dollarisation, become bodies with no power.
    • Cryptocurrencies have the potential to be a medium of exchange and replace the rupee in financial transactions both domestic and cross border.
      • This is one of the reasons why RBI has opposed it, and the Indian finance ministry has backed them by imposing a 30% crypto tax on it without officially 'allowing' it in India.
    • This move aimed to stall Indian rupees going up into purchasing virtual assets which will then be owned by foreign entities - that cannot be tracked by tax authorities here.
    • The tax does not apply to individuals who mine cryptos to earn them but only to those who spend Indian rupees to acquire or trade in it.
  • Threat to Financial Sector of the Country:
  • Negative Impact on the Banking System:
    • It will also have a negative impact on the banking system as these being attractive assets people may invest their hard-earned savings in these currencies which may result in banks having lesser resources to lend.
      • There are an estimated 15 million to 20 million crypto investors in India, with total crypto holdings of around USD 5.34 billion.

Way Forward

  • The US dollar is still the favoured currency for trade because no other currency is liquid enough. Even if a currency does, there would be apprehensions in nations about that currency becoming a mirror of the US dollar.
  • A mere change in regime along with having to bear the same manipulations albeit from a different country is not what the world wants. The only way forward would be to diversify the currency market with no one currency claiming hegemony.

Source: ET

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