India should focus on internationalisation of rupee not de-dollarisation

The US dollar holds a dominant position as a reserve currency in global trade.

(Sanghnomics is a weekly column that tracks down and demystifies the economic world view of Rashtriya Swayamsevak Sangh (RSS) and organisations inspired by its ideology.)

The issue of de-dollarisation is back in the debate. US President-elect Donald Trump recently threatened that the US would impose a 100 per cent tariff on countries that press for de-dollarisation. His statement is assumed to be primarily targeted at BRICS, of which India is a member. Trump's statement apparently came in the wake of the recent BRICS summit in Kazan, Russia, where member countries of this trade bloc discussed ways and means to boost non-dollar transactions. India's own trade and transactions are heavily dependent on the US dollar.

Dominance of the US Dollar

The US dollar holds a dominant position as a reserve currency in global trade.  Around 58 percent of all foreign exchange reserves are held worldwide in US dollars.  Incidentally, the  International Monetary Fund (IMF), recognizes eight major reserve currencies: the Australian dollar, the British pound sterling, the Canadian dollar, the Chinese renminbi, the euro, the Japanese yen, the Swiss franc, and the U.S. dollar. The US dollar however continues to hold the dominant position as a reserve currency.

Importance of a Reserve currency

A reserve currency is a foreign currency that is held by the Central bank of a country as a part of its foreign exchange reserves. These reserves are held for a variety of reasons – to pay for imports, to absorb economic shocks, to pay interest on loans and to manage the values of a country’s own currency.

As much of the international trade is still in dollars, countries across the globe need dollars in their treasury to import goods and services which are crucial for their survival and important for their development.

Because of the power of the US dollar, the US treasury markets remain highly liquid and that compels central banks of other countries to hold a large number of US bonds as they can be encashed easily when required.

Weaponisation of dollar

One of the catalysts for the efforts to de-dollarise the world economy is the way the US has weaponized dollar to target the regimes that it considers to be their adversaries. According to a Chatham House report, “Freezing Russian foreign exchange reserves in February 2022 is certainly the most aggressive weaponisation of the dollar to date, following similar (but much smaller) assaults on the central banks of Libya, Iran, Venezuela and Afghanistan.  The theory is that the dollar’s use as a foreign policy tool and over-use of sanctions like these could make more countries worry about losing access to their dollars, encouraging a tilt away from the dollar to other alternatives.”

Anshu Sripurapu and Noah Beram  explained aptly the dominance of dollar as they wrote in a paper for Council of Foreign Relations, “Factors that contribute to the dollar’s dominance include its stable value, the size of the U.S. economy, and the United States’ geopolitical heft. In addition, no other country has a market for its debt akin to the United States’, which totals roughly $22.5 trillion. “It’s more helpful to think of U.S. treasuries as the world’s leading reserve asset,” says CFR’s Brad W. Setser. “It’s hard to compete with the dollar if you don’t have a market analogous to the treasury market.”

Way ahead: Internationalisation of Rupee

India needs to adopt an affirmative strategy of strengthening the internationalisation of the Indian rupee. The Modi government has already made significant strides in this direction. Banks of 22 countries including Russia, UK, Germany and Israel have opened accounts in Indian banks to trade in Indian currency. These accounts are called Vostro accounts. In a written reply in Lok Sabha in July 2023, Union Minister of State (External Affairs) Rajkumar Ranjan Singh listed out the names of the countries. They include Belarus, Botswana, Fiji, Germany, Guyana, Israel, Kenya, Malaysia, Mauritius, Myanmar, New Zealand, Oman, Russia, Seychelles, Singapore, Sri Lanka, Tanzania, Uganda, Bangladesh, Maldives, Kazakhstan and the United Kingdom.

According to an RBI report that dealt with this issue at length in 2023, “For promoting internationalisation, India needs to encourage trade invoicing in INR, as is already permitted. From a purely strategic point of view, it makes sense to settle bilateral trades in INR. This can be done initially with regional partners. Further, invoicing and settling of international trade transactions in INR with trade partners with whom we have a trade deficit (say, the oil exporting countries) will in general lead to a reduction in the current account deficit denominated in convertible currencies. Commensurately, there will be a reduced need to maintain large foreign exchange reserves in convertible currencies.

There is some anecdotal evidence that INR is accepted to some extent in Singapore, Malaysia, Indonesia, Hong Kong, Sri Lanka, United Arab Emirates (UAE), Kuwait, Oman, Qatar and the United Kingdom (UK), among others, while it is legal tender in Nepal and Bhutan. The Nepal Rastra Bank, Royal Monetary Authority of Bhutan and Bank Negara Malaysia also hold Government of India securities and Treasury Bills. Some sovereigns, like Singapore, hold Indian equity and bond assets (including G-secs) through their sovereign wealth funds.”

Conclusion

While the US dollar continues to hold the sway, internationalisation of rupee is a long -drawn process. India has made steady progress on this front under the Modi government. There is, however, still a long way to go.

Earlier Sanghnomics columns can be read here.