De-Dollarisation and its Impact on Indian Economy

Understanding De-dollarisation

De-dollarisation is a topic that’s been making waves in the global economic landscape and its implications for India are both intriguing and multifaceted. Let’s dive into the concept and explore how it might influence the Indian economy.

De-dollarisation refers to the gradual shift away from the dominance of the U.S. dollar in international trade and finance. Many countries, including India, have been exploring ways to reduce their reliance on the dollar due to various economic and geopolitical reasons.

The US dollar’s status as the world’s primary reserve currency can be traced back to the Bretton Woods Agreement in 1944. In the early 1970s, President Richard Nixon announced a bold economic plan, including the severing of the U.S. dollar’s ties to gold, the US dollar solidified its position with an agreement with the oil-rich Kingdom of Saudi Arabia to conduct global energy trade in dollars. The status of the dollar was enhanced by the collapse of the Bretton Woods system, it essentially eliminated other developed market currencies from competing with the USD. Currently, about 60% of the foreign exchange reserves of central banks and about 70% of global trade are conducted using the USD. The psychological angle to considering the USD as a “safe-haven” asset is that people continue to view the currency as a relatively risk-free asset.

Furthermore, sudden dumping of dollar assets by adversarial central banks will put their balance sheets at risk by eroding the value of their overall dollar- denominated holdings. Apart from the Euro and gold, most other foreign currencies have some inherent risks associated with them.

Impact on Indian Economy

India, the world’s fifth-largest economy, as a member of the BRICS group of nations, which collectively represents about 42% of the world’s population and a significant portion of global GDP, India has been actively engaging in efforts to challenge traditional financial architecture. The BRICS bloc has established institutions like the New Development Bank (NDB) and the Contingent Reserve Arrangement (CRA) to provide financial support for member countries and foster cooperation outside the Western-dominated financial system.

India is a key player in the process of de-dollarisation. While the US dollar remains dominant, the use of other currencies like the Euro, the Japanese Yen, and the Chinese Renminbi has been on the rise, along with the Indian Rupee. De-dollarisation has brought about an increase in trade denominated in local currencies, including the Indian Rupee. This development has given India more leeway in setting monetary policy and protecting its economy from external shocks.

A significant portion of India’s trade is conducted in U.S. dollars. To reduce vulnerability to external shocks, De-dollarisation is imperative which can insulate the Indian economy from external shocks and changes in US monetary policy. India need to promote trade in local currencies, this shift in trade dynamics will provide greater stability to Indian exporters and importers, shielding them from abrupt currency fluctuations that can negatively impact business operations and profits.

De-dollarisation will have more autonomy in setting India’s monetary policy, contributing to better control over inflation and overall Indian economic stability. India holds a substantial amount of foreign exchange reserves, a significant portion of which is in U.S. dollars. Diversifying these reserves into other currencies or assets can mitigate risks associated with a potential devaluation of the dollar.

De-dollarisation may foster stronger economic ties between India and other countries which will enhance trade relations. Engaging in bilateral and multilateral trade using local currencies can eliminate the need for intermediation through the U.S. dollar, potentially streamlining transactions and reducing costs.

De-dollarisation efforts could contribute to a stronger Indian rupee, reducing inflationary pressures and enhancing the country’s purchasing power. By using local currencies in bilateral trade, India may have more control over its trade balance, potentially reducing trade deficits.

De-dollarisation can provide India with greater economic independence, reducing vulnerability to U.S.-led sanctions or economic pressure.

Challenges and Implications

Shifting away from the dollar involves significant transition costs. Countries need to build the infrastructure for alternative payment systems, negotiate new trade agreements, and ensure the stability of their own currencies.

The success of de-dollarisation depends on the global acceptance of alternative currencies. The international community must be willing to adopt and use these alternatives in trade and financial transactions.

As a part of de-dollarisation efforts, countries might reconsider their investment portfolios. For India, this could mean a shift in the composition of its foreign exchange reserves, potentially impacting returns and risk profiles.

Conclusion

While de-dollarisation poses challenges, it also presents significant opportunities for India. A careful and strategic approach, coupled with international cooperation, can help India navigate this economic shift and potentially emerge stronger on the global stage. Diversification away from the US dollar is intended to protect economies from geopolitical risks. Much has been written about how the weaponisation of trade, the imposition of sanctions, and the US’s exclusion from SWIFT could accelerate de-dollarisation because countries with diplomatic and economic autonomy will be wary of using US-dominated global banking systems. This school of thought contends that this will also cause a shift in the overall global forex market framework, as potential foreign policy coercion or sudden disruptions will not sit well with countries, prompting them to investigate how to build fortress.

The US dollar, the world’s reserve currency, may continue to fall in value in the current environment as leading central banks seek to diversify their reserves away from it and into other assets or currencies such as the Euro, Renminbi, or gold. The concept of de- dollarisation fits well in the thought experiment of a multipolar world in which each country seeks economic autonomy in the realm of monetary policy. The main objective is to understand and examined the opportunity and challenges of de-dollarisation on the Indian economy.