Context: While countries have tried to dethrone the dollar as the global reserve currency for many decades now for various reasons, of late such attempts have picked up pace in the aftermath of Russia’s invasion of Ukraine last year.
Status of Global Currencies
- According to the BIS Triennial Central Bank Survey 2022, in terms of foreign exchange market turnover (daily averages), the dollar was the most dominant currency accounting for 88 per cent of the global forex turnover in 2022, followed by the Euro (31 percent), Japanese Yen (17), and Pound Sterling (13); the rupee accounted for a mere 2 percent of global currency market turnover.
- Similarly, as per IMF’s COFER data, the dollar’s share of global foreign exchange reserves during 2022 Q4 stood at 58.4 percent, followed by Euro (20.5), Japanese Yen (5.5), Pound Sterling (5), Chinese Renminbi (2.7), Canadian dollar (2.4), Australian dollar (2), and Swiss Franc (0.2); India’s share was negligible.
What is De-dollarisation?
- De-dollarisation refers to the replacement of the U.S. dollar by other currencies as the global reserve currency.
- Attempts to de-dollarize have picked up pace in the aftermath of Russia’s invasion of Ukraine last year. The U.S. imposed several sanctions that restricted the use of the U.S. dollar to purchase oil and other goods from Russia, and this has been seen by many countries as an attempt to weaponise the dollar.
- Currently, the Chinese yuan is seen as the primary alternative to the U.S. dollar owing to China’s rising economic power.
Advantages of Reserve Currency
- A reserve currency refers to any currency that is widely used in cross-border transactions and is commonly held as reserves by central banks. The currencies of economic superpowers that have usually ended up being used as the global reserve currency.
- When a country’s fiat currency enjoys reserve currency status, it gives the country the power to purchase goods and other assets from the rest of the world by simply creating fresh currency out of thin air.
- Other currencies such as the British pound and the French franc have served as international reserve currencies in the past. As the economic clout of these countries waned, their currencies faced a similar downfall. This was the case, for example, with the British pound which was gradually replaced by the U.S. dollar as Britain lost its status as a global economic superpower in the first half of the 20th century.
- The global reserve currency status of the US Dollar gives it unfair privileges over other countries, thus justifying de-dollarisation attempts by many countries.
- Since international transactions carried out in the U.S. dollar are cleared by American banks, this gives the U.S. government significant power to oversee and control these transactions.
Popularity of US Dollar
- The U.S. dollar is widely used in international transactions because people actually prefer to use the American currency over others for various economic reasons.
- Other currencies are not as popular as the greenback for carrying out international transactions. For example, a recent attempt by India and Russia to carry out trade between the two countries in Indian rupees rather than in U.S. dollars has hit a roadblock because the value of India’s imports from Russia far outweighs its exports to the country. This left Russia with excess rupees in hand which it was unwilling to spend on Indian goods or assets, and led to Russian demands for the settlement of bilateral trade in U.S. dollars.
- The global acceptability of the U.S. dollar has primarily been attributed to the popularity of U.S. assets among investors. The U.S. has been running a persistent trade deficit for decades now (the value of its imports has for a long time exceeded the value of its exports to the rest of the world). The excess dollars that the rest of the world accumulates due to the U.S’ trade deficit has been invested in U.S. assets such as in debt securities issued by the US government. The high level of trust that global investors have in the U.S. financial markets, perhaps owing to the ‘rule of law’ in the U.S., is considered to be a major reason why investors prefer to invest in U.S. assets.
- China, for instance, which supplies the world with huge volumes of goods and runs a trade surplus, has been trying to make the yuan a reserve currency. However, restrictions placed by the Chinese government on foreign access to China’s financial markets and doubts over ‘rule of law’ in China have adversely affected global demand for the yuan.
Reasons for De-dollarisation
- Irresponsible expansion of the money supply can cause the debasement of the currency and eventually threaten its status as a reserve currency.
- Expansionary monetary policy adopted by the U.S. Federal Reserve over the decades to argue that this could threaten the U.S. dollar’s status as a global reserve currency. The U.S. central bank usually increases the supply of dollars through various means to tackle economic downturns and also to fund the U.S. government’s expenditures.
- However, the U.S. Federal Reserve is not the only central bank in the world that has been debasing its currency by engaging in expansionary monetary policy over several decades. Other countries have also been expanding their respective money supplies to address their domestic economic problems. As long as the U.S. does not debase its currency at a faster pace than other countries, the dollar may manage to hold its value against other currencies and hence its reserve currency status may not come under serious threat.
Way Forward for India: Rupee Invoicing for Foreign Trade
- Rupee invoicing became a buzzword post the July 2022 RBI circular that allowed invoicing, payment and settlement of trade (exports/imports) in Indian rupee.
- Foreign Trade Policy (FTP) 2023 wants to thrust exports on the wheels of rupee invoicing that proposes both trading partners raising their invoices and settling payments for their transactions on a bilateral basis in rupees. The framework facilitates invoicing of exports and imports in rupee, market-determined exchange rates between currency pairs of the trading partners, and trade settlement via Special Rupee Vostro Account (SRVA).
- The benefits of rupee invoicing are manifold, especially during geopolitical unrest and when economic sanctions are levied against India’s major trade partners.
- Amongst the benefits, the prominent ones are lowering of transaction costs, a greater degree of price transparency, quick settlement time, promoting international trade, reduction in hedging expenses, reduced cost of holding foreign reserves by the RBI and, most importantly, internationalisation of the rupee.
- Analysis shows that invoicing in rupee would be more favourable with trade partners such as Russia, Saudi Arabia, Nigeria and the UAE, where India is a large importer and potential exists for Indian exports as well.
- Some of the countries that hold potential for trade settlement in rupee are shown in the Chart.
- India’s policy of facilitating trade in rupees has been gaining momentum, with the total number of SRVAs reaching 60 in a span of seven months (Rajya Sabha question on March 14). Eighteen countries have opened SRVAs to facilitate overseas trade in rupee. Of these countries, India recorded a trade deficit with eight — Botswana, Germany, Guyana, Malaysia, Myanmar, Oman, Russia and Singapore — in FY22.
Conclusion:
- The effectiveness of rupee trade, however, ultimately depends on whether India is running a net trade deficit or surplus with the participating trading partners, as well as the extent of trading in rupees in comparison to the total bilateral trade.
