Cryptocurrencies and Dollarisation of Economy

In News

• Recently, top officials of the RBI said that Cryptocurrencies can lead to “Dollarisation” of a part of the economy. 

About the recent developments in Cryptocurrency sector

• Tax on trading: The Union Budget presented this year introduced a tax on trading in cryptocurrencies and related assets like non-fungible tokens (NFTs) at a flat 30 per cent and one per cent of the tax will be deducted at the source (TDS) when any such transaction takes place.
• Data and Statistics: There are an estimated 15 million to 20 million crypto investors in India, with total crypto holdings of around USD 5.34 billion.
  • No official data is available on the size of the Indian crypto market.
• RBI and SEBI: As statutory bodies, both RBI and SEBI report to Parliament and the panel has the parliamentary responsibility to call upon the officials of these regulators over the financial and economic issues of the country.  

What do you mean by dollarisation of the economy?

• Dollarisation is a form of currency substitution, where dollars are used in addition to or instead of the local currency of a country.
  • Ideally, the extensive use of cryptos should cause ‘cryptorisation’.
• Crypto currencies are dollar-denominated and also issued by foreign private entities which could lead to dollarisation.
• They are also known to have said that cryptocurrencies have the potential to become a medium of exchange and replace the rupee in financial transactions both domestic and cross-border thereby replacing a part of the Indian monetary system.
• Apart from being used as payment for goods and services, cryptos can also be exchanged for fiat currencies and the US Dollar is the most preferred for this exchange.
• Most Indians who buy cryptos, convert rupees to dollars, in order to buy them.

Associated issues with dollarisation of economy

• It will seriously undermine the RBI’s capacity to determine monetary policy and regulate the monetary system of the country.
• These currencies can replace a part of the monetary system; it will also undermine the RBI’s capacity to regulate the flow of money in the system.
• Besides being used for terror financing, money laundering and drug trafficking, cryptos pose a bigger threat to the stability of the financial system of the country.
• 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.

Dollarisation and its Implications on the economy

• 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.
• 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.
• In spite of its current inflation troubles, India is far away from dollarisation to this extent.
  • However, there are research papers that suggest that 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 showing that few countries use their own currencies for international transactions due to the popularity of the dollar abroad.

Way Forward

• Extra vigilant: The central bank is always worried about the movement of the Indian rupee and now more than ever it is extra vigilant with high inflation, devaluation and of course fears of possible stagflation looming large.

Source: ET