De-Dollarization and India

De-Dollarization and India

Why in the News?

Recent financial and currency initiatives, particularly within the BRICS+ framework, aim to reduce dependence on the US dollar and create alternative mechanisms for global trade and finance, a process referred to as de-dollarization.

De-dollarization Explained
De-dollarization refers to efforts to reduce the dominance of the US dollar in global trade, finance, and foreign exchange reserves. This process involves replacing the US dollar with other currencies or assets—such as gold, cryptocurrencies, or regional currencies—used for international transactions, commodity trading (like oil), and reserve holdings.

Recent Financial and Currency Initiatives for De-dollarization

1. mBridge Project
   The mBridge project is a cross-border payment system using Central Bank Digital Currencies (CBDCs), initially supported by countries like China and Thailand with backing from the Bank for International Settlements (BIS). However, some speculate that the BIS withdrew its support under US pressure to preserve dollar dominance.

2. BRICS+ Initiatives
   The BRICS+ group, which includes the original BRICS nations (Brazil, Russia, India, China, South Africa) and new members such as Egypt, Ethiopia, Iran, the UAE, and Indonesia, has proposed financial systems like BRICS Bridge and BRICS Clear to establish a payment and clearing system among these countries.

3. Petro-Yuan Market
   The Shanghai International Energy Exchange (2018) handles a significant portion of global oil trade, with Saudi Arabia and the UAE’s shift to non-dollar oil trades boosting the petro-yuan’s credibility as a stable alternative to the US dollar.

4. BRICS Currency
   At the 16th Kazan BRICS summit in 2024, the member nations agreed in principle to create a new settlement currency, the "Unit," which would be backed by 40% gold and 60% local currencies of the member countries.

Global Benefits of De-dollarization

• Reduced Geopolitical Risks: Countries can shield themselves from US sanctions and foreign policy actions that leverage dollar dominance, like freezing assets. For instance, following Russia’s 2022 invasion of Ukraine, over USD 300 billion in Russian assets were frozen.

• Diversification: De-dollarization encourages multi-currency usage, reducing dependence on a single currency and fostering a more balanced global financial system.

• Strengthening Regional Currencies: Countries can enhance their currencies for trade, strengthening economic sovereignty and reducing exchange rate risks, such as India’s oil trade with the UAE in rupees.

• Reduced Vulnerability to US Monetary Policy: Countries are less affected by US policy shifts (e.g., interest rate changes), minimizing impacts like capital flight and currency devaluation.

• Increased Use of Gold: De-dollarization has revived interest in gold as a stable reserve asset, offering an alternative to fiat currencies.

• Promotion of Digital Currencies: The trend also accelerates the development of digital currencies and blockchain payments, with examples like China’s digital yuan and India’s Digital Rupee (e₹).

Concerns Associated with Global De-dollarization

• Short-Term Instability: Sudden shifts in currency reserves or trade agreements could create market volatility, as the dollar remains integral to global trade.

• Limited Acceptance of Alternatives: Currencies like the yuan, rupee, and ruble lack the liquidity, stability, and global trust that the US dollar commands.

• Risk of Fragmentation: De-dollarization could lead to competing currency blocs, potentially fragmenting the global economy and complicating international trade.

• Geopolitical Tensions: The US may respond aggressively to efforts aimed at reducing dollar dependency, potentially escalating trade wars and sanctions.

• Global Repercussions: A decline in the dollar’s status could reduce demand for US debt, resulting in economic instability in the US, with global ramifications due to its size and influence.

• Exchange Rate Determination Issues: Without the dollar as a global benchmark, countries may need to rely on a multi-currency basket, complicating exchange rates. For example, India and Russia are still negotiating a currency exchange rate based on their local currencies.

India’s Stand on De-Dollarization and Its Impacts

• India’s Position: India engages in BRICS+ currency discussions but remains cautious, asserting that it has no intention to undermine the US dollar, which it views as essential for global financial stability.

Benefits for India

• Promotion of the Indian Rupee: De-dollarization encourages the use of the Indian rupee in bilateral and multilateral trade agreements, such as India’s oil trade with Russia in rupees.

• Increased Monetary Policy Autonomy: Reducing reliance on the dollar gives India more control over monetary policy, allowing it to manage inflation and interest rates without being affected by US policy shifts.

• Diversification of Reserves: De-dollarization allows India to diversify its reserves into currencies like the euro, yen, yuan, or even gold, reducing the risks associated with dollar devaluation.

• Reduced Exposure to US Sanctions: By reducing dependence on the US dollar, India can mitigate its vulnerability to US-led sanctions, increasing geopolitical flexibility.

• Decreased Reliance on SWIFT: By moving away from dollar-based systems like SWIFT, India’s financial system becomes less exposed to risks from sanctions.

Concerns for India

• Impact on Foreign Investment: A move away from the dollar might deter foreign investors who prefer the stability and predictability of dollar-denominated assets.

• Challenges in Diversifying Reserves: Alternatives to the dollar, such as gold or other currencies, might expose India to new risks, such as currency depreciation or commodity price fluctuations.

• Over-reliance on the Chinese Yuan: India risks becoming overly dependent on the Chinese yuan, which could lead to geopolitical and economic challenges.

• Impact on Remittances: De-dollarization might disrupt India’s dollar-denominated remittances, affecting millions of families who rely on these transfers.

What Lies Ahead for India?

• Strengthening the Rupee: Expanding bilateral trade in rupees, like the India-UAE oil trade, and promoting currency swaps and regional frameworks such as BRICS+ initiatives.

• Internationalizing UPI, RuPay, and Digital Rupee (e₹): These platforms can be used for cross-border transactions, positioning India as a leader in digital finance.

• Diversifying Reserves: Reducing USD reliance by diversifying reserves into the euro, yen, yuan, gold, and IMF SDRs, while developing sovereign wealth funds and commodity reserves for stability.

• Managing Risks: Maintaining a multi-currency trade system, strengthening relationships with ASEAN, the EU, and Africa for diversified trade, and ensuring investor confidence in the rupee.

• Strengthening India’s Financial Position: Positioning Mumbai as a global financial hub, boosting bond market liquidity, and advocating for a multi-currency system through the IMF, G20, and other international bodies.

Drishti Mains Question:
Discuss the concept of de-dollarization and its implications for India’s economy.

UPSC Civil Services Examination Previous Year Questions (PYQs)

Prelims
Q. Consider the following statements: (2019)

• Most of India’s external debt is owed by governmental entities.

• All of India’s external debt is denominated in US dollars.
  Which of the statements is/are correct?
  (a) 1 only
  (b) 2 only
  (c) Both 1 and 2
  (d) Neither 1 nor 2
  Ans: (d)

Q. Recently, which one of the following currencies has been proposed to be added to the basket of IMF’s SDR? (2016)
(a) Rouble
(b) Indian Rupee
(c) Rand
(d) Renminbi
Ans: (d)

Mains
Q. How would the recent phenomena of protectionism and currency manipulations in world trade affect macroeconomic stability in India? (2018)

Q. The craze for gold among Indians has led to a surge in gold imports, putting pressure on the balance of payments and the rupee’s external value. In light of this, examine the merits of the Gold Monetization Scheme. (2015)

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